How does APR work?
As we have already said, the APR is an annual percentage rate expressed as an interest rate. It is used to calculate the percentage of capital that will be paid each year taking into account aspects such as monthly payments. The APR is also the annual interest rate paid on investments without considering the compounding of interest during that year.
How is the APR calculated?
The APR is calculated by multiplying the periodic interest rate by the number of periods of the year during which it was applied. It does not indicate how many times the rate is actually applied to the balance.
APR = ((((Fees + Interest) / Principal) / n) × 365 ) × 100
where:
Interest = Total interest paid over the life of the loan
Principal= Loan amount
n = Number of days of loan duration
Financial instruments may have different ways of calculating this interest rate. For example, in a credit card, these values vary according to the type of debt, the credit history of the person, and in some cases the level or type of credit card. In addition to this, other factors such as cash advances, late payments, or other functions of said cards may also be taken into account, which may affect the APR.
For its part, bank loans usually have a fixed or variable APR. A fixed APR loan has an interest rate that is guaranteed not to change for the life of the loan or credit. A variable APR loan, on the other hand, has an interest rate that can change at any time, depending on the terms of the loan. market, regulatory, or any element that the banking entity deems relevant to take into account.
In any case, the APR does not take into account the capitalization of interest over a given year: it is based solely on the simple interest applied to the funds.
What is APY?
APY or Annual Percentage Yield, on the other hand, refers to the actual yield interest that will be earned in a year if the interest is compounded. Compound interest is periodically added to the total invested, increasing the balance, so the next interest calculation will take into account the new balance, applying the given interest. This means that each interest payment will be higher, depending on the higher balance. The more often the interest is compounded, the better the return.
How is the APY calculated?
Calculating the APY is quite simple and we can do it using the following formula:
APY = ((1 + r/n) ^ n) – 1
Where:
r = is the annual interest
n = the number of compound periods per year
So for example we have to:
If we invest €5000, with an annual interest of 12.68%, compounded monthly, we will obtain an APY of 12%
APY = ((1 + 12%/12) ^ 12) – 1
APY = 12,68 %
Which means our €5000 will become €12.68 * 5634.13% = €5000. This would be the annual compound interest we will get for an APY of 10%.
What is the difference between APR and APY?
While APR only takes simple interest into account, Annual Percentage Yield (APY) takes compound interest into account. Therefore, the APY of a loan is greater than its APR. The higher the interest rate – and to a lesser extent, the shorter the compounding periods – the greater the difference between the APR and APY.
Imagine the APR on a loan is 12% and the loan is compounded once a month. If an individual borrows €5,000, his interest for one month is 50% of the balance, or €5,050. This brings the balance to €1,50.5. The following month, an interest of XNUMX% is applied to this amount, and the interest payment is €XNUMX, slightly higher than that of the previous month.
If you carry this balance forward throughout the year, your effective interest rate becomes 12.68%. Instead, the APY includes those small changes in interest charges due to compounding while the APR does not, which is the main difference between the two concepts.
What do APR and APY mean in the crypto world?
In the crypto world, APR is an element widely used in the DeFi world or in centralized investment and lending instruments with cryptocurrencies. While most major DeFi and crypto funding providers use APY, you can also use APR in many of them, especially when taking out a loan, leaving APY when investing in a platform and expecting rewards. . Although it depends on the decision of the DeFi application development teams, this aspect may vary.
But in AAVE, for example, you earn in APR, which reduces the chances of winning that we can obtain on this platform by placing our cryptocurrencies there.
As you can see, each platform has its own formula, it's up to you to find which one can give you the best rewards (DYOR), without putting your funds at risk.
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