With the popularity of cryptocurrencies surging and the crypto market capitalization reaching an all time high of $3.3 trillion in November ‘21, it’s clear that this is an industry that is here to stay. According to Yahoo Finance’s 2021 crypto user statistics, 43% of Americans between the ages of 18 and 29 have traded or used cryptocurrency, and we see high usage in countries with volatile native currencies such as Nigeria (32%), Vietnam (21%) and the Philippines (20%).
As adoption increases and users become more familiar with using digital currencies, naturally they look to see other ways they can use their cryptocurrencies in addition to holding them as an investment. With the introduction of stablecoins, which are cryptocurrencies normally pegged to the value of the US dollar, users now have the opportunity to swap their fiat money to a non-volatile digital currency and perform many of the activities that they are used to within the traditional financial system, using their cryptocurrencies.
One such example is using stablecoins to earn higher interest rates than seen within traditional finance. Stablecoins can be used to earn interest both via centralized cryptocurrency exchanges and through decentralized finance (DeFi) protocols – where we often see interest rates of around 8-20% APY. With inflation on the rise and traditional savings interest rates hugging the floor, many people are turning to their cryptocurrencies to earn higher returns.
- What is APY?
- What is the difference between APR and APY?
- What is compound interest?
- How do you calculate APY?
- Why is crypto APY so high?
- Key takeaways
Naturally, one of the questions that comes to mind is what is APY in crypto. So let’s discuss.
What is APY?
The Annual Percentage Yield (APY) is the rate earned on an investment over the course of a year, taking into account the effects of compounding interest.
What is the difference between APR and APY?
APR and APY might sound similar, but the difference is important to understand as it can make a huge difference to your returns. The key difference between the Annual Percentage Rate (APR) and the APY, is that APY takes into account compounding interest. In DeFi, APR can also mean Annual Percentage Reward.
What is compound interest?
At its simplest, compound interest is interest that you earn on top of previously earned interest. Knowing this, it’s easy to understand why the more frequently your interest is compounded, the more interest you will earn over the longer term. With traditional banks, often the interest is compounded monthly or annually. In the cryptocurrency realm, compounding tends to be far more frequent – with 7 day APY commonplace and some providers even offering daily compounding. Some DeFi protocols including Aave compound every mined block, which is every 13 seconds on average on the Ethereum network.
The impact can be vast.
Let’s take the scenario that you’re saving for a house deposit with $10,000 in your savings account and you’re making regular deposits of $500 monthly.
At a big bank with an interest rate of 0.25%, after 5 years you’ll end up with $40,310.89. A mere $310.89 earned in interest over 60 months. At an 8% interest rate – you can see the difference below.
How do you calculate APY?
APY is calculated by adding 1+ the periodic rate as a decimal and multiplying it by the number of times equal to the number of periods that the rate is applied, then subtracting 1.
APY = (1 + Periodic Rate)Number of periods – 1
Why is crypto APY so high?
Cryptocurrency APYs are higher primarily because of the reduced overheads involved. Bank’s pay out for the infrastructure to run their operations whereas in DeFi, everything is automated via smart contracts. Sometimes you will also earn a percentage of the transaction fees generated within the protocol or exchange you are using.
Some centralized providers offer ‘fixed’ interest rates, usually over a short time period. However, it’s important to note that the APY is usually variable and whilst you see high rates quoted, these frequently change and are usually not guaranteed over the long term.
Often, the higher the interest rate, the riskier the product. So whilst 8-20% is considered a normal rate, most products offering higher than 30% tend to be relatively high risk.
DeFi rates are often calculated each mined block, and are impacted by the value of the assets in the pool you are contributing to. So for example, if you are depositing assets into a USDC saving pool, the APY will be higher when there are less assets in the pool, and reduce when there are more.
You might see what seem like outrageously high interest rates on some of the more high risk protocols – sometimes up to 10,000% APY. These are known as yield farms and require a high level of understanding to use competently. Whilst the quoted interest rates are high, these are often extremely short term and most proficient yield farmers move their assets regularly, often only staying in a farm for a matter of days.
You’re able to earn interest on certain cryptocurrencies and stablecoins via centralized exchanges and DeFi protocols. This can be a great way of generating passive income whilst holding your cryptocurrencies. APY is the interest rate you receive inclusive of the compound interest you earn on the interest you receive during the period.
If you’re looking for an easy way to earn APY, download our wallet – Minke. We give you access to various DeFi savings protocols, allowing you to easily earn interest on various cryptocurrencies, including stablecoins.