What is APR and How to Calculate It

Holding and borrowing crypto assets is your go-to method for making money from cryptocurrency. It's good to know exactly how much your investment will bring in, right? There are two metrics that help guide you on what kind of return to expect with a particular investment: the Annual Percentage Rate (APR) and the Annual Percentage Yield (APY). There are nuances in the handling of these metrics. As with everything in the world of cryptocurrencies, it is better to understand them in detail, otherwise you may miss something really profitable: products with a higher APY will not necessarily generate more income than products with a lower APR and vice versa. It's even more interesting with products that have the same rate – you'll have to look and compare. How exactly this works, what to consider and how not to get confused — we tell you in detail!

What is APR

In the most general terms, the Annual Percentage Rate (APR) is the basic metric for calculating the cost of a loan or investment over the course of a year. It is expressed in percentages and essentially denotes the amount a borrower pays a lender for their services or the earnings an investor can potentially accrue from their investments – precisely our scenario. APR is computed as a simple interest rate. In contrast to the so-called “compound” rate, APR does not account for interests accumulated on other interests – a role designated to the APY metric. While APR serves as a valuable tool for grasping the fundamental profitability of investments, it falls short in providing a comprehensive view when contrasting investments with compound interest. We'll delve further into handling compound interest shortly, alongside a comparison between APY and APR. For now, it's paramount to grasp the significance of these metrics for crypto investors.

What is APR in Crypto

When a crypto investor allocates funds to a staking pool, provides loans, or participates in liquidity farming/pools, they, as creditors, anticipate rewards for their services. These rewards often manifest in the form of interest, with the annual interest rate showcasing how much the creditor will gain beyond their initial investment post-transaction closure. In the realm of cryptocurrency, APR is typically utilized concerning the profitability of engaging in financial operations. Understanding APR proves beneficial in comparing investment offers and making informed decisions that maximize profitability. While APR may appear straightforward, unraveling APY necessitates comprehension of the concept of compound interest. Put simply, it signifies the returns on your investment considering the interest accrued for services rendered – be it weekly, monthly, or annually, depending on the offer. Therefore, if your offer entails more frequent payouts than annually, the deal's balance can progress throughout the year, while APR remains fixed.

How to calculate APR

The good news is that regular users typically don't need to calculate this percentage on their own – you'll find the necessary figures in the offer itself, after which you may opt to utilize one of the online investment calculators. However, for transparency, understanding how this operates is beneficial. The formula for calculating APR consists of the interest rate only and includes all additional transaction costs, may vary from product to product, but is generally considered using this formula:

A = [P × (1 + R × T)] Where:

A = total final amount

P = the principal amount, i.e. the amount of the initial investment or loan

R = interest rate used

T = time (in years)

APY, on the other hand, as we've sorted out, includes compound interest and makes the calculation a slightly more, well, complex because it includes interest accruing on both the original principal amount and any previously accrued interest. It's important to pay attention to how often interest is paid out: the more frequent the payouts, the more they accumulate. This affects the APY figure. This can happen daily, monthly, quarterly, or annually. Therefore, it is crucial to compare investment opportunities among themselves and calculate the APY for each one – allowing you to accurately assess the profitability of each scenario.

The formula for calculating APY is as follows:

APY = (1 + r/n)^(n*t) - 1 Where:

r - nominal interest rate (in decimal fractions).

n - number of reinvestment periods per year.

t - time (in years).

How else do you use this in your investments? For example, you are considering two offers: one with 5% APR that accrues monthly, the other has 5% APR accruing every 6 months. In this case, you need to calculate the APY for both of the offers and determine which investment will yield more profit.

Calculating:

Monthly reinvestment: APY = (1 + 0.05/12)^(121) - 1 ≈ 0.0512 or 5.12%

Semi-annual reinvestment: APY = (1 + 0.05/2)^(21) - 1 ≈ 0.0506 or 5.06%

In this scenario, the platform with monthly accruals will provide slightly higher returns due to the frequent interest accumulation, so investment in this offer will be more favorable.

APR vs APY

Let's summarize the differences between APR and APY.

Interest Calculation

APR represents the annual percentage rate. It does not account for compound interest, unlike APY, which provides a more accurate estimate of actual earnings.

Complexity

APR is a simpler metric that considers only the basic interest rate. On the other hand, APY takes into account both the rate and the frequency of payouts on your investment, making the calculation more complex.

Comparability

APR is suitable for comparing investments with a similar reinvestment frequency, while APY allows for a fair comparison of various investments with different reinvestment structures. Realistic Returns: APR may underestimate the actual profitability of investments with frequent reinvestment periods, whereas APY provides a more realistic view of overall returns.

Therefore, it's more convenient to use one or the other indicator for each operation. Let's consider specific scenarios.

Emergency Loans: When assessing cryptocurrency loans with a simple interest structure, APR is best suited. It enables the comparison of annual interest rates of different loans without considering compounding.

Staking Rewards without Reinvestment: For calculating income from a staking plan without reinvestment, APR is the most appropriate metric.

Savings Accounts or Credit Platforms with Reinvestment: When comparing savings accounts or credit platforms offering compound interest, it is preferable to use APY. APY takes into account the compound interest effect and provides a more accurate reflection of overall profitability.

Crypto Farming with Reinvestment: If you are evaluating the profitability of crypto farming on DeFi platforms where rewards are automatically reinvested, APY is the most suitable. It allows for comparing the total returns of different crypto farming strategies and selecting the most suitable option.

Does it make more sense now? We hope so — you can now try out your knowledge in practice. But that's not all! There's plenty more on our blog about other phenomena in the world of cryptocurrencies. Be sure to check it out so you don't miss something important for your investment.