Recently, while researching DeFi products, I found that many people are confused about the concepts of APR and APY. Actually, their differences seem simple, but they have a significant impact on your actual returns, so it's worth understanding them well.

First, let's talk about the meaning of APR, which is more straightforward — it’s the annual percentage rate, representing the interest rate you can earn from your funds in one year. For example, if you deposit $10k and the APR is 20%, then after one year, you’ll earn $2,000 in interest, and the principal plus interest will become $12k. Two years would be $14k, three years $16k, growing linearly without any complicated factors.

But APY is different. The core of APY is compound interest — meaning "interest on interest." Suppose the same 20% APR, but the bank pays interest monthly. Each month, the interest you earn is automatically added to the principal, so next month you can earn interest on a larger amount. Over a year, instead of earning $2,000, you would earn $2,429. If compounded daily, after a year, you could earn $2,452. It looks similar, but over three years, daily compounding can grow your final amount to $19.31k, compared to $16,000 without compounding, earning you an extra $3,309. The power of compounding is truly remarkable.

Therefore, the higher the compounding frequency, the greater your returns. That’s why understanding APY is important — it already accounts for compounding. The same 20% APR, compounded monthly, is equivalent to about 21.94% APY; compounded daily, it’s about 22.13% APY.

This is especially critical when comparing different DeFi products. Some report APR, others report APY. Comparing them directly can easily mislead you. You need to convert them into the same terminology to make a fair comparison. Also, even if two products both use APY, you should check whether their compounding frequencies are the same, because daily versus monthly compounding can lead to significant differences in final returns.

Another point to pay special attention to — in crypto products, sometimes APY represents the token rewards you can earn, not fiat currency returns. This is crucial because even if you keep earning tokens with high APY, if the token’s price drops significantly, your total investment value (measured in fiat) might still decrease. So, always carefully review the product terms and understand what APY truly means in that context — don’t be fooled by high yields.

To sum up simply: APR is a static annual interest rate, while APY includes the effect of compounding, so APY is usually higher than APR. Remember this, and when comparing products, use the same terminology to avoid pitfalls. Recently, I’ve also seen many DeFi products on Gate; if you’re interested, you can compare them yourself and evaluate which ones are more cost-effective using this logic.