Recently, while exploring DeFi products, I noticed that many people are confused about the concepts of APY and APR. Actually, I was initially confused myself. Today, I want to share my understanding in hopes of helping everyone.

Simply put, what is APY? It’s the annual percentage yield, which takes into account the effect of compounding. APR is the annual interest rate, excluding compounding. These two may seem similar, but in reality, the difference is quite significant.

Let’s start with APR, which is relatively straightforward. Suppose you deposit $10k on a platform with an annual interest rate of 20%. After one year, you earn $2,000 in interest, totaling $12,000. After two years, it’s $14,000; after three years, $16,000. The calculation is direct: principal multiplied by the rate, once per year, without compounding.

But what if the platform pays interest monthly? That involves compounding. Each month, you earn some interest, and that interest becomes the principal for the next month. This way, your money grows like a rolling snowball. The same $10k with a 20% annual rate, but with monthly compounding, you’d end up with about $12,429 after a year, earning an extra $429 compared to simple APR. If compounded daily, it would be around $12,452.

This difference becomes more pronounced over the long term. Under the same conditions, after three years, daily compounding can grow your investment to about $19,309, whereas without compounding, it remains at $16,000—a difference of over $3,000.

So, what is APY? It’s the annualized yield that accounts for the effect of compounding. For example, a 20% APR with monthly compounding results in an APY of 21.94%. With daily compounding, the APY reaches 22.13%. That’s the power of compounding.

In DeFi, this distinction is crucial when choosing products. For the same interest rate, the more frequently the interest is compounded, the more you ultimately earn. So, when comparing two products, don’t just look at the APR; see how they handle compounding. Some products may advertise a high APR but have low compounding frequency, resulting in a lower APY than a product with a lower APR but more frequent compounding.

Another detail to note is that some DeFi platforms state the annualized return in tokens rather than fiat currency. This means you earn rewards in tokens, not cash. Even if you consistently earn token rewards, if the token price drops, your total investment value could still shrink. So, when choosing products, do your homework: understand what APY really means, what risks are involved, and don’t just chase numbers blindly.

In summary: APY considers the effect of compounding, while APR does not. The more frequent the compounding, the greater the gap between APY and APR. In DeFi investing, always compare products with the same compounding frequency to truly see which offers better returns.