APY

What is APY?

APY (Annual Percentage Yield) is the total yearly return on an investment, including the effect of compounding interest. It reflects the "real" rate of return if earnings are reinvested into the principal.

How does APY work?

1. APY accounts for interest earned on previous interest within a year.

2. The formula for APY based on a periodic rate is:

   APY = (1 + r/n)^n - 1

   (where r is the APR and n is the number of compounding periods).

3. More frequent compounding (e.g., daily vs. annually) results in a higher APY.

4. In DeFi, many protocols automate compounding to maximize user returns.

5. APY is usually higher than APR for the same nominal interest rate.

Why does APY matter?

APY provides the most accurate picture of an investment's earning potential over a year. It allows users to compare different yield-bearing opportunities effectively, taking the power of compounding into account.

Key features of APY

• Includes compounding effects
• Higher than simple APR
• Standardized annual metric
• Influenced by compounding frequency
• Reflects actual "take-home" yield

Examples of APY

• A savings account with 4% APR compounded monthly resulting in ~4.07% APY.
• A yield aggregator offering 20% APY by auto-compounding rewards daily.
• Staking ETH to earn a variable APY based on network activity.