What Is Annualized Percentage Yield In Crypto?

Overview

We know your average savings account pretty much offers peanuts when it comes to interest. But this isn't the case with crypto yields, leading to an increase in investors seeking these elusive rewards.

The annual percentage yield (APY) is not unique to digital currencies, but it's much higher than in other markets. There is always an incentive to attract investors, particularly towards newer projects.

Also, the non-existence of regulation offers free reign when it comes to the earning potential in interest.

So, let's learn about APY, the factors influencing it and why you should stay away from projects offering unusually high yields.

What is an annualized percentage yield?

The APY is the yearly return rate that accounts for compound interest. The latter refers to what you earn from your principal deposit and the accumulated interest over a certain period.

We can compound interest over several periods. But, we commonly view overall earnings over a year.

Let’s explore a simple example illustrating how APY works by comparing it to simple interest. If you deposited $10 000 into a savings account with a yearly rate of 5%, you would have made $500.

But, if you did the same with crypto using the same rate and six months of compounding, your final earnings would be $512. This is how we got to this amount:

$500 divided by 365 days X 182.5 days = $250 (interest after six months)

At this point, your balance is now $10 250. 5% of this amount equals $512.5, representing the final amount you would have accumulated after a year from $10 000. Thus, the actual APY in this case, is 5.12%.

Factors influencing APYs in crypto

As one would expect, many factors affect the extent of crypto yields. One of the most significant is inflation, referring to the loss of value in a currency over time.

A blockchain network can have an inflationary or deflationary token supply. Inflationary distribution can negatively affect the APY because if more coins get created, they become less valuable. Meanwhile, a blockchain with non-inflationary tokenomics is more attractive to investors.

The second influential element is basic supply and demand. Generally, if there is more demand for a cryptocurrency, we should expect greater yields; the opposite is, of course, true.

Lastly, the other influential factor is the compounding period. If compounding happens more frequently, the greater your potential earnings.

Crypto investments involving APY

Below are the types of crypto investments where you will come across annual percentage yields:

Lending/borrowing

This is where you put up your crypto assets on a lending protocol like Nexo or BlockFi, which then lends them out to other institutions or borrowers on their platform. In the case of borrowing, you will be shown APRs.

Staking

Staking occurs on a proof-of-stake blockchain where holders ‘lock up’ their coins for a specific period to secure the network. The blockchain autonomously confirms transactions based on the size of your stake without computer mining.

Yield farming

Yield farming is an all-encompassing term for earning crypto on your crypto, to which staking is a subset. However, in most cases, we generally mean ‘locking’ up your coins in an automated DeFi pool to provide liquidity for a certain market. We refer to this as 'liquidity mining.'

The dangers of projects offering unusually high yields

The APY you can receive with cryptocurrencies varies widely. If one stakes or saves with any of the coins in the top 50, the most to expect here is around 10%.

With stablecoins, the most APY you typically find is 20%. The next category can start from this point up to several hundred or even thousand in percentage. This is quite prevalent with obscure altcoins listed on experimental DeFi protocols.

For context, the BCH-BNB liquidity pool (according to CoinMarketCap) on PancakeSwap offers a ridiculous 1065871% APY. You may be wondering how the potential returns can be so incredibly high and whether there’s more than meets the eye.

It all boils down to attracting many investors and price volatility. When a new cryptocurrency is listed, liquidity is one of the major challenges. Therefore, one method is for developers to offer astronomically high yields.

However, in almost all cases, investors would have bought an inflationary token.

As previously mentioned, the higher the inflation, the less you make in the long run, decreasing your rate of return. Coins in these protocols are known for having whales buying thousands of these tokens due to their cheap prices.

Thus, if one or a few individuals sell their tokens, this crashes the price, decreasing your earnings.

Put simply, the greater the APY, the greater the risk.

Curtain thoughts

Having a good understanding of APYs can prevent you from falling into the trap of being attracted to projects offering above-average returns. When considering any yield-based crypto investment, you should observe the earlier-mentioned factors.

Cryptocurrencies have opened a world of unimagined lucrativeness. However, we should always appreciate that this financial instrument can be incredibly volatile, leading to huge losses.