APR is the annualized rate without compounding. APY is the annualized rate assuming compounding.
In traditional finance, those definitions are usually enough. In DeFi, they are only the starting point because many yields are variable, may include reward tokens, and can change minute to minute with utilization.
DeFi frontends often display APY because many protocols auto-compound interest, and because compounding is a powerful marketing lever.
Money markets continuously accrue interest as borrowers pay interest and suppliers earn it. Some apps also reinvest rewards into the position to increase the displayed yield.
The catch is that APY is an assumption. It assumes the same rate continues for a year and the compounding process continues without interruption.
In DeFi, neither assumption is guaranteed.
Suppose a protocol offers 10% APR on a stablecoin deposit.
If interest is not compounded, the outcome over a year is 10%.
If interest compounds frequently, the APY becomes slightly higher than 10%, because interest earns interest.
That difference is usually modest at normal rates. It matters more when rates are very high or compounding is very frequent.
The bigger problem is not the math. The bigger problem is that the rate and the compounding method can change, and the displayed APY often does not reflect the real-world friction costs.
DeFi lending and borrowing is two-sided.
A supplier earns a supply APY. A borrower pays a borrow APR or borrow APY, depending on how the interface presents it.
Net APY is what matters for strategies that borrow and lend at the same time.
For example, a user may supply ETH, borrow USDC, and then use USDC elsewhere to earn yield. The strategy’s true performance depends on:
A supply APY is never the full story when leverage exists.
Most DeFi rates are utilization-driven. If borrow demand spikes, borrow rates rise and supply rates often rise too. If demand falls, rates compress.
A displayed APY is a snapshot. It is not a promise.
A large share of “high APY” in DeFi comes from rewards paid in a token.
If that reward token price falls, realized yield falls, even if the displayed APY looked stable.
This effect is especially strong in the early phase of incentives, where emission schedules are high and liquidity is thin.
Some products assume auto-compounding. Others assume manual compounding. Others show an APY that requires claiming and reinvesting rewards.
If a user does not compound at the assumed frequency, realized yield is lower.
For smaller positions, compounding may not be worth the transaction costs.
A more reliable approach is to break yield into components.
Base interest comes from borrowers paying interest. It is typically the most durable component.
Incentives come from token emissions. They can be profitable but should be treated as temporary and price-sensitive.
Realized yield is what remains after:
An APY that looks high can become mediocre when costs and operational constraints are included.
A yield is only valuable if it can be exited.
Thin liquidity can trap users during volatility. Lending markets are safer when liquidations and withdrawals can clear smoothly.
A lending market APY is usually simple. Deposit earns interest sourced from borrowing.
A strategy vault APY can be a bundle:
Bundled APY can be legitimate, but it requires understanding what risks are being added.
Rates change fast in DeFi, so a lightweight checklist helps.
First, confirm whether the number is APR or APY.
Second, confirm what portion of the yield is base interest versus reward tokens.
Third, confirm whether compounding is automatic.
Fourth, confirm whether the rate is variable and how it is set.
Fifth, confirm the exit path: liquidity depth, withdrawal constraints, and whether bridging is required.
Sixth, for borrow-based strategies, confirm the liquidation buffer and the scenario where the collateral drops quickly.
One common confusion is comparing a supply APY to a borrow APR directly, without accounting for collateral requirements and liquidation risk.
Another is treating “APY” as risk-free, especially when it is paid in volatile reward tokens.
A third is ignoring time. A promotional APY can be real for a week, then fall sharply as emissions drop or as liquidity enters.
APR and APY are both useful, but neither should be treated as a promise in DeFi. APR ignores compounding. APY assumes compounding and stable rates. In DeFi, rates are often variable, incentives can dominate the headline number, and compounding assumptions can break in practice.
The safer approach is to separate base interest from incentives, estimate realized yield after costs, and treat exit quality and liquidation mechanics as part of the yield calculation. A lower yield with cleaner mechanics often produces a better outcome than a higher APY that depends on fragile assumptions.
The post DeFi APR vs APY: What You Need to Know appeared first on Crypto Adventure.
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