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Not yet sure if I want to make Crypto Basics a recurring series of posts or not. But I thought that this topic was at least worth a closer look and a post of its own. And if I find other such topics I will add them to the series as well. Let us dive in.
New to crypto
If you like me are new to crypto you might not yet be all that familiar with all the terms and acronyms that get thrown around. But you probably have seen these three, APY, APR, and ROI, all over the place, I know I have. But you might not know what they mean, and even if you know what the acronym means, you might not really know what the difference between them is.
The goal of this post is that after you have read it from start to finish you will then know the basics of what all three mean. And how they work, and why you see them almost everywhere. But you almost never see more than one of them at a time.
We will start off with APR. APR stands for Annual Percentage Rate. Annual means something that occurs once every year. For us, you can just think of it as meaning 365 days later. Percentage, this is something that is done for ease of use and the ability to be able to compare things with each other. For us, this just means that they have taken whatever amount you have at the start, and used that as a reference point. That means that that amount is equal to 100%. Rate, in this setting, means a fixed price paid or charged for something.
If we now use the meaning of the word to explain APR we will get the following; After 365 days you will have gotten this much on top of what you started with.
One important note is that very rarely do you have to "lock" your assets for 365 days in order for you to get the APR. Usually, you will get 1/365 of parts added each day.
APR is usually used when you borrow or invest capital. It is fairly straightforward to calculate. As an example, if I invest $100 at an APR of 10%. This means that after 365 days I would now have $110, 10% more than what I started off with. The rate I got annually is then $10. But if I would have withdrawn my money after 37 days. Instead of getting $10, I would now get 10 * 37/365 = just over $1.
How much you get for stopping early depends on how often part of the rate gets added. Usually, this is done once every day, but it can vary so you will need to verify this for yourself. If the information is not available then ask the support.
APY stands for Annual Percentage Yield. Just as with APR we can think of annually as it means 365 days later. Percentage, just as with APR is used in the same way here. And it means whatever amount you have at the start, and used that as a reference point and 100%. Yield, the use and meaning of the word here are derived from agriculture or industries. It means how much have you gotten or will get.
If we now take a look at APY and put the meaning of the words together. We will get the following; After 365 days you will get this much, on top of what you started out with.
Hold your horses. Am I saying that APR and APY basically mean the same thing? Yes, yes I am. There is however a technicality that makes them very different. And this is the part I will get to now.
The thing that sets them apart is that APY takes compounding into account. And what is that you might ask. When we talk of compounding, we also must talk about how often we are allowed to compound. But first, let us focus on what compounding means for us. When we get to compound it means that we get to take the earnings we have made up to that point. And we can then add it to our initial starting amount. This new amount then will become the 100% used for calculating the yield for the next period.
If you like math, this is what the formula to calculate the APY looks like.
If we use the same example as we did for calculating APR. We then can use the formula above to calculate the APY on the same investment. The r, in the equation, will be the same 10% as above. Let us start and see what happens if we can compound 12 times in a year, this puts n = 12.
Let me save you the time it takes to use the calculator. This then comes out to an APY of ~10.47%. So with our $100, we would after a year now have $110.47. Not that huge of a difference maybe. But over time it adds up.
The important thing to take note of if you see an APY is the compounding periods. There can be some tricky sites that get to show you a high APY and then say this is reached with daily compounding. But what they do not take into account is the gas fee you then get to pay daily having to manually compound your savings.
Some sites however do have automatic compounding. Make sure you find out which it is that is used where you plan to invest. And how often the compounding happens.
Now we come to the last of the acronyms. That has a nice ring to it, ROI, the last of the acronyms. Sorry for getting sidetracked. ROI stands for Return On Investment. Return means getting something back. On here just tells you what you will get a return from. Investment means the investing of money or capital. Hopefully, this is done with a profit. A thing to note also is that ROI is always told in percentage form.
To calculate the ROI you can use the following formula:
If we use the examples above we get the following ROI. On the APR we had a cost of $100, and our current value of the investment is $110. This will get us:
110 - 100 = 10, this is then divided by 100, 10/100 = 0.1 and to convert this to % we simply multiply it by 100. Resulting in an ROI of 10%.
If we do the same for the APY example we then get an ROI of 10.47% instead.
In a sense ROI is the baby brother or sister to both APR and APY. What I mean by that is this. If we now put everything we have learned together. We can now say things like the following:
I invested $100 in this company that promised an APR of 20%. But I had to cash out my investment after half a year so that cut into my ROI making it a measly 10%.
And hopefully, we now understand what all of it means. At least that was the goal with this post. I hope that you have found it informative and helpful. And if you like me to try and explain another crypto term or mechanism please let me know in the comment section down below.
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I have also just started a new series of weekly posts, that will go live every Friday. You can catch the fifth step here:
How playing board games has helped me with crypto - My Journey to Financial Freedom
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