Recently, while looking into DeFi products, I found that many people are still a bit confused about what APY means. In fact, it’s not just beginners—some even experienced players sometimes mix up APY and APR, which ultimately leads to completely different calculations of returns.

First, let’s start with the simplest one: APR is the annual interest rate. If you deposit 10,000 US dollars at an annual interest rate of 20%, you earn 2,000 US dollars in interest after one year, 4,000 after two years, and 6,000 after three years—just that straightforward linear calculation. But this method has a problem: it doesn’t take compounding into account.

Compounding is the real magic. Suppose your interest isn’t calculated just once a year, but instead calculated every month. Then the interest newly generated each month is added to the principal, so next month you calculate interest using a larger principal. As a result, the interest you earn keeps increasing. For example, using the same 10,000 US dollars and a 20% interest rate, if you compound monthly, after one year you’ll have 12,194 US dollars, which is 194 US dollars more than 12,000 US dollars without compounding. What if you switch to daily compounding? Then it’s 12,213 US dollars. It looks pretty similar, but the longer the time period, the more obvious the effect becomes. After three years, the same 20% product with daily compounding will give you 19,309 US dollars—3,309 US dollars more than without compounding.

This is what APY means. In Chinese, APY is called the annual yield rate—it’s the actual annual return once the compounding effect is factored in. A 20% APR compounded monthly is effectively equivalent to an APY of 21.94%. With daily compounding, it’s an APY of 22.13%. So when you see a product advertising an APY, it means it already reflects the real annualized return after considering compounding.

In DeFi, this difference is especially important. When comparing two products, you must make sure you’re using the same metric. Some products show APR, while others show APY—direct comparison is like comparing apples and oranges. And even if both are APY, the compounding frequency still affects the actual returns. If one compounds monthly and the other compounds daily, the final amount of the cryptocurrency you receive will be different.

One more thing to note: in DeFi products, APY is denominated in cryptocurrency, not fiat currency. So even if your APY looks high, if the price of your crypto asset crashes, the value of your investment calculated in fiat terms could still decline. That’s why you need to read the product terms yourself and understand where the risks are.

To sum it up simply: What does APY mean? It means the true annualized yield after taking compounding into account. Remember this, and you won’t be misled by the numbers when choosing DeFi products or staking schemes. The higher the compounding frequency, the higher the APY—but only if you make sure the risks are clearly understood.