Recently, while researching DeFi products, I found that many people are confused about the concepts of APR and APY. Actually, the difference between the two is quite crucial, especially when it comes to compound interest.

Simply put, APR is the annual percentage rate, which is the fixed interest rate for lenders or borrowers over a year, not considering compounding. But APY is different; it’s the annual yield that includes compound interest. This may sound like a small difference, but the actual returns can vary significantly.

For example, you deposit $10,000 at 20% APR into a platform. Ignoring compounding, after a year you earn $2,000 in interest, and the total amount is $12,000. But what if the platform calculates interest monthly? The situation changes. Each month, you receive some interest, and that interest becomes the principal for the next month, continuing to generate interest. That’s the power of compounding.

The same 20% APR, if compounded monthly, results in $12,429 after a year, earning $429 more than without compounding. What if it’s compounded daily? That would be $12,452. The higher the compounding frequency, the more you earn. Over longer periods, the difference becomes even more dramatic. Under the same conditions but extending the interest calculation period from one year to three years, with daily compounding, you could end up with $19,309, earning $3,309 more than a simple APR.

So, when a product tells you it offers compound interest, how do they calculate your returns? That’s where APY comes in. A 20% APR compounded monthly is equivalent to a 21.94% APY; compounded daily, it’s about 22.13% APY. These APY figures represent the actual annualized return you can expect to receive.

When comparing different DeFi products, be especially careful. Never compare a product’s APR directly with another’s APY, as they are not directly comparable. You must use the same terminology. And even if both products use APY, check whether their compounding frequencies are the same. One compounded monthly, the other daily—your final returns will definitely differ.

Another important point: in crypto products, APY sometimes refers to the tokens you earn as rewards, not fiat currency returns. This distinction is critical because crypto asset prices fluctuate. Even if your APY looks high and you earn a lot of tokens, if the token’s price drops significantly, your total investment value (measured in fiat) might still be in loss. So, when evaluating any DeFi product, always read the terms carefully, understand what APY really means in that specific context, and assess the risks.

In summary, remember one key point: APY is higher than APR because it accounts for compounding. The more frequent the compounding, the greater the difference. Next time you research a product, first check whether they’re quoting APR or APY, then decide whether to invest.