What is APY?

APY, or Annual Percentage Yield, in the context of cryptoassets, refers to the percentage of rewards a user can earn by participating in staking, liquidity pools or lending within the cryptoasset ecosystem.

Below you will find the answers to the most frequently asked questions:

• How does APY work? 
• What is compound interest?
• Risks of APY
• Example of APY calculation

How does APY work? 

APY takes into account the effect of compound interest and provides a more accurate measure of the reward obtained from participating in such activities compared to the simple annual interest rate (APR).

What is compound interest?

Compound interest is a way of calculating interest that is based on reinvesting the interest earned into the original principal, resulting in an exponential growth rate. That is, the interest earned in one period is added to the original principal and reinvested, resulting in a larger principal for the next period. This larger principal, in turn, generates more interest, which is again added to the original principal and reinvested, and so on.

Risks of APY

It should be clarified that APY, per se, has no risks as such, given that it is only a mathematical formula. There may be some risks related to the use made of this APY, focused mainly on the market in general. These are:

• Market volatility: cryptoassets can experience significant fluctuations in their value, which could affect the actual return obtained through APY.
• Unforeseen variability: APY is calculated based on factors such as supply and demand at any given time. This is why there may be a variation in real terms of the reward's price without prior notice. 

Example of APY calculation

It can be calculated using the following formula:

APY = ((1 + r/n) ^ n)  – 1

Where:

r = is the annual interest

n = the number of compound periods per year

Thus, for example, we have that:

If we invest €5,000, with an interest of 12% per year, with a monthly compound, we will obtain an APY of 12,68 %

APY  = ((1 + 12%/12) ^ 12) – 1

APY = 12.68%

Which means that the €5,000 will become €5,000 * 12,68 % = 5634,13 €. That would be the annual compound interest that would be obtained for an APY of 12,68 %.