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Understand how APY works in crypto. Learn the difference between simple and compound interest and how to spot high-inflation yield traps.
Annual Percentage Yield (APY) is a percentage figure you might have seen on more than one occasion when navigating crypto platforms.
It’s commonly thought of as an interest rate; but unlike simple interest, APY reflects the growth that occurs when your crypto rewards are reinvested to earn even more rewards.
Read this guide to understand how APY works, how it differs from APR and the risks of chasing high yields.
Annual Percentage Yield (APY) is a metric that tracks the total rewards you may earn on a digital asset over one year, including the effect of compounding.
In crypto, this figure is used to compare the potential performance of assets across DeFi lending protocols or reward-earning platforms.
The defining characteristic of APY is compounding. Simple interest only calculates returns based on your original deposit. APY assumes that the rewards you earn are added back to your principal. This process creates a cycle where you earn rewards on your rewards, which may lead to exponential growth over time.
In the crypto market, APY is usually variable. This means the rate can shift based on market demand, the total amount of assets locked in a protocol, or network activity. Because of this variability, the APY you see today might be different from the rate you receive six months from now.
The ‘secret sauce’ of APY is compounding frequency. The more often your rewards are compounded – whether it is daily, weekly or monthly – the higher your overall token yield will be.
Even if two platforms offer the same base rate for locking up your crypto, the one that compounds daily will result in a higher APY than the one that compounds monthly.
In a typical crypto scenario:
In crypto, this process can happen much faster than in traditional finance. As blockchains operate 24/7 without bank holidays, some protocols can calculate and add rewards to your balance every few minutes. This high-velocity reinvestment is what allows some crypto platforms to offer rates that appear much higher than traditional savings products.
The frequency at which rewards are added to your balance – compounding frequency – is a critical variable in your final yield. Here’s a look at the different frequencies and how they affect the initial capital:
For example, if you have a 10% base rate on $1,000, compounding it once a year gives you $1,100. If you compound that same rate daily, you would end up with approximately $1,105.16.
The difference may seem minute on a short timeline, it becomes a significant factor when managing larger amounts or holding for several years.
While they look similar, APY and APR (Annual Percentage Rate) tell two different stories. APR is the simple interest rate; it tells you how much you may earn in a year, but it assumes you’re withdrawing your rewards as you earn them, rather than reinvesting them.
If you see a 10% APR and you start with $1,000, you can expect to have $100 in rewards at the end of the year. However, if that same 10% is listed as an APY with monthly compounding, your actual return would be higher because you’re earning interest on your interest each month.
Feature | APR | APY |
Compounding | Not included (simple interest) | Included (compound interest) |
Calculation | Periodic rate x number of periods | (1 + periodic rate)^periods - 1 |
Result | Usually a lower number | Usually a higher number |
Usage | Common for loans and credit cards | Common for savings and rewards |
Investors and traders should always check whether a rate is quoted in APY or APR. If a platform quotes a high APR, the ‘real’ yield could be even higher once compounded. Conversely, if you aren't reinvesting your rewards, the APY figure might give you a misleading expectation of your returns.
A ‘7-day APY’ is a trailing average that looks at the rewards generated over the last week and projects that performance over a full year.
This metric is a snapshot of current demand. If a protocol sees a sudden spike in network fees or trading volume, the 7-day APY might spike. However, this doesn’t mean the rate will stay that high for the rest of the year. Traders sometimes monitor the 7-day APY to gauge current activity, but they avoid using it as a long-term guarantee.
Chasing the highest advertised number can be a dangerous strategy. A high APY would likely mean taking on extra, unnecessary risks.
Risk | Description |
Inflation trap | Some new tokens or projects offer triple-digit APYs to attract users. However, if the token supply is increasing faster than the demand, the price of each token may drop. You might have 50% more tokens at the end of the year, but they could be worth 80% less in dollar terms. |
Price volatility | Rewards are usually paid in the native token of a protocol. If that token’s market price crashes, your ‘yield’ vanishes. A 20% APY can’t offset a 50% drop in the asset's underlying value. |
Liquidity and lock-ups | To earn the highest rates, you may have to lock your assets for months. During this time, you cannot sell your tokens, even if the market starts to decline. |
Smart contract vulnerabilities | High-yield DeFi protocols are often experimental. If the code is compromised, your entire principal could be at risk, regardless of the advertised yield. |
Why is crypto APY so much higher than bank interest?
Crypto protocols are automated by code and don't have the overhead costs of physical banks. Additionally, high rates are often a reward for providing liquidity to new or volatile markets.
Does APY change over time?
Most crypto APYs are variable. As more people join a pool to earn rewards, the individual share of those rewards usually decreases, leading to a lower APY.
Is APY the same as profit?
Not necessarily. APY measures the growth in the amount of tokens you have. Your profit only becomes clear once you account for the market price of the tokens and any network fees paid to claim them.
How often does compounding happen in crypto?
It varies by protocol. Some compound daily, some every few minutes and others require you to manually ‘claim’ and reinvest your rewards, which may incur network fees.
Important information:
This article is for informational purposes only and should not be construed as financial or investment advice. Trading cryptocurrencies involves risks, including price volatility and market risk. Past performance may not indicate future results. There is no assurance of future profitability. Before deciding to trade cryptocurrencies, consider your risk tolerance.
Services, features, and other benefits referenced in this article may be subject to eligibility requirements and may not be available in all markets. They may also be subject to change at the discretion of Crypto.com.
