What are these two concepts and how do they differ?
As investors navigate the world of decentralized finance (DeFi), they will become increasingly familiar with two terms; Annual Percentage Rate (APR) and Annual Percentage Yield (APY).
Although they sound similar, they represent different concepts and can significantly affect the returns you can expect to earn on your assets.
This article will define these two terms and provide an example for each that illustrates the difference between APRs and APYs and enhances investors’ understanding of these concepts, and how to apply them.
Contents
- APRs (Annual Percentage Rates)
- APRs On GHOST
- APY (Annual Percentage Yield)
- APYs Explained
- Borrowing/Lending On GHOST
- Article Summary
- Useful Links
APRs (Annual Percentage Rates)
Investors often wish to open various market positions, requiring them to borrow funds.
After executing their desired trades, they are required to repay the loan with interest, with this amount calculated as follows:
Principal Amount x APR (interest rate)
Hence, APRs describe the cost of borrowing a particular asset to an investor over a 1-yr time period, with this rate expressed as a percentage of the principal amount.
Let’s now explore how APRs work, using the lending market for $USDC on GHOST as an example.
APRs On GHOST
Example — An investor deposits $5,000 USDC into a vault with a 5.00% APR.
In this case, after one year, your interest is calculated by multiplying the principal amount ($5,000) by the APR (5.00%).
Year 1
Interest: $5,000 × 0.05 = $250
Total amount: $5,000 + $250 = $5,250
Year 2
Interest: $5,000 × 0.05 = $250
Total amount: $5,250 + $250 = $5,500
Year 3
Interest: $5,000 × 0.05 = $250
Total amount: $5,500 + $250 = $5,750
Assuming the APR is a fixed yearly rate, the interest accrued will remain the same. So, an investor lending at this rate would earn $250 per year.
However, interest is accrued only on the principal amount as opposed to the gain in the total amount each year.
This is the key difference from APYs, which we will explore now.
APY (Annual Percentage Yield)
APYs, on the other hand, utilize compound interest to act on the interest of an investor’s earnings, and are calculated as follows:
Principal Amount x APY (interest rate)
The key difference from APRs is the frequency at which the principal amount is compounded, which directly affects the investors’ returns.
Further, the interest accrued over a specific time period is continually added to the principal amount, increasing the level of investment each time it is compounded.
Let’s look at how APYs work, using the same example as above.
APYs Explained
Example — An investor deposits $5,000 USDC into a vault with a 5.00% APY with a yearly compounding frequency.
In this case, after one year, your interest is calculated as follows:
Year 1
Interest: $5,000 × 0.05 = $250
Total amount: $5,000 + $250 = $5,250
At the beginning of Year 2, the APY takes into account the principal amount ($5000), in addition to the interest accrued in Year 1 ($250).
Year 2
Interest: $5,250 × 0.05 = $262.50
Total amount: $5,250 + $262.50 = $5,512.50
Hence, interest will be earned on this new, higher amount ($2,250) instead of the principal amount.
Year 3
Interest: $5,512.50 × 0.05 = $275.63
Total amount: $5,512.50 + $275.63 = $5,788.13
At the end of this 3-year period, the investor receives $5,788.13, considerably more than the return generated by the APR ($2,750).
Evidently, given that APYs tend to have a higher compounding frequency, the returns an investor should expect to make will be higher than that of APRs, in a given time frame.
Borrowing/Lending On GHOST
On GHOST, all interest rates are represented as yearly APRs, providing a reliable, consistent return for users investing over long time frames.
To view the available lending markets and their respective interest rates, navigate to GHOST.
Upon deciding which token you would like to lend, specify the amount and confirm the transaction via SONAR or KEPLR.
Manage and track your position on the easily accessible and user-friendly GHOST dashboard.
Note
Since GHOST is a decentralized money market, suppliers are covered even if borrowers fail to repay their loans.
Further, all loans are overcollateralized, meaning borrowers can access loans on GHOST with ease without having to fill in lengthy applications for loans or go through strenuous credit checks. It’s truly a win-win.
Article Summary
Whether you are a lender or a borrower, understanding the differences between APR and APY can help you optimize your strategies, maximize returns, and effectively participate within the Kujira ecosystem.
So, to briefly summarize:
APRs
- Investors will accrue interest when lending an asset, in the form of an APR.
- This APR is applied to the principal amount and does not take into account any interest accrued as a result of the loan.
- The APR is a fixed rate over a specified time period (i.e. 1 year).
APYs
- Investors will accrue interest when lending an asset, in the form of an APY.
- This APY is applied to the principal amount, and any interest accrued over the specified time period.
- The higher compounding frequency of APYs results in a higher return on investment when compared to APRs, assuming the principal amount and time period are constant.
GHOST
- Navigate to the GHOST dashboard to view lending markets and the different APRs stated for each asset.
- Navigate your borrowing/lending positions through GHOST, scaling in/out of your positions when necessary.
By now, you should be able to define APRs and APYs, explain the core differences between them, and manage your borrowing/lending positions with ease.
Thanks for reading, and keep an eye on our socials, we’ve got a big week ahead of us!
Useful Links
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Kujira Academy is a platform that aims to bridge the gap between young entrepreneurs and Web3, providing them with tangible education and career acceleration opportunities. Built by students, for students. Learn more about the academy and our vision here.
To register your interest and become a student of Kujira Academy, click here.
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