APY (Annual Percentage Yield)
Yearly return that includes compounding.
APY, or annual percentage yield, estimates a one-year return after including the effect of compounding. Compounding means earned rewards are added to the principal and can generate further rewards. APY provides a useful comparison when reinvestment is realistic, but it is an annualized projection rather than a guaranteed payout.
For example, a position with 12% APR that compounds monthly has an APY of about 12.68% before fees and other changes. The extra return comes from earning on prior monthly rewards. If the rate compounds only once at year-end, the APY and APR are both 12%. More frequent compounding increases the theoretical APY, although the benefit becomes smaller with each added interval.
In DeFi, compounding can be manual or automatic. A user may claim staking rewards and deposit them again. A yield vault may collect rewards from many users, swap them, and reinvest the proceeds. Automatic strategies can save effort and spread transaction costs, but they add smart contract, strategy, swap, administrator, and fee risks. A vault's share price may reflect compounded value even when a user does not receive separate reward tokens.
APY matters because a small difference in compounding can become significant over long periods. It also makes marketing easy to misunderstand. Interfaces sometimes annualize a very recent reward rate, producing a large number that would require token prices, emissions, and demand to stay unchanged for a year. A seven-day historical APY is not evidence that the same yield will continue.
To compare products, check the base rate, compounding schedule, payout token, fees, lockup, and calculation window. Determine whether the displayed APY is current, trailing, fixed, or variable. Include gas and performance fees in net yield. Token depreciation, impermanent loss, validator penalties, depegs, and liquidation can outweigh balance growth. A million-percent APY paid through rapid token inflation may destroy purchasing power rather than create it.
Measure realized performance from actual cash flows and market values instead of relying only on a dashboard. Keep records of deposits, withdrawals, and rewards, especially where taxes apply. Stress-test lower rates and adverse token prices, and evaluate contract security and withdrawal liquidity. APY can standardize return comparisons, but only when competing figures use credible and similar assumptions.
Frequently asked questions
- APY includes returns earned on previously reinvested returns, while APR does not. With a positive rate and more than one compounding period, APY is therefore higher than the matching APR. The difference grows with the rate and compounding frequency. A quoted APY is meaningful only if its rate stays stable and reinvestment occurs as assumed.
- It depends on the protocol and product. A vault may automatically reinvest rewards after a profitable harvest, while another position compounds only when the user claims and deposits again. Some interfaces calculate a theoretical per-block APY even though practical compounding is less frequent. Read the method and include harvest gas, performance fees, delays, and minimum thresholds.
- Record the initial deposit, later deposits and withdrawals, rewards, fees, and ending value in one chosen currency. Separate token quantity growth from token price movement. Use time-weighted or money-weighted returns when cash flows occur during the period. Compare the realized net result with the advertised APY and remember that a short observation cannot confirm a projected annual yield.