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DeFi

APY (Annual Percentage Yield)

Menno van Ravels - Alpha Factory

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AI Quick Summary: APY (Annual Percentage Yield) Summary

Term

APY (Annual Percentage Yield)

Category

DeFi

Definition

APY (Annual Percentage Yield) measures the actual annual return on an investment including compounding effects.

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APY (Annual Percentage Yield) measures the actual annual return on an investment including compounding effects. In DeFi, APY can be dramatically higher than APR because rewards are frequently reinvested, but high APY figures often reflect temporary incentives or unsustainable token inflation.

APY and APR (Annual Percentage Rate) measure returns differently. APR is the simple interest rate without compounding. APY accounts for compound interest — reinvesting earnings to generate earnings on earnings. The formula is: APY = (1 + APR/n)^n - 1, where n is the number of compounding periods per year. For daily compounding, a 100% APR becomes 171% APY. This gap is why DeFi protocols typically advertise APY — it looks larger and accounts for automated compounding.

In DeFi, APY figures can appear astonishingly high — sometimes 1,000%+ for new yield farms. These numbers deserve extreme skepticism. Most 'high APY' comes from token emissions: the protocol is minting and distributing its own governance tokens as rewards. If the token's price collapses (which it often does when emission rates are high), the APY in real dollar terms may be deeply negative. The sustainable APY from fee revenue — trading fees, interest spreads, real yield — is typically in the 3–20% range for established protocols, not 500%. Olympus DAO (OHM) famously advertised 8,000% APY in late 2021 — the rebase rewards were sustainable only as long as new buyers kept entering, and the token crashed 99% from its peak.

Real yield — APY backed by actual protocol revenue rather than token inflation — became a key concept after the 2022 bear market destroyed many inflation-dependent strategies. Protocols like GMX, Gains Network, and Curve's 3pool distribution to veCRV holders were lauded for offering real yield from trading fees. When evaluating any high-APY DeFi opportunity, the first question should be: where does this yield actually come from?

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Frequently Asked Questions

How do I calculate what 100% APY actually means for my investment?

With daily compounding (typical in DeFi), 100% APY means roughly doubling your position in 1 year if you compound daily and the rate holds constant. In practice, rates change constantly. A simpler mental model: 100% APY ≈ 0.27% daily. At 50% APY ≈ 0.14% daily. Use a compound interest calculator and input the daily rate over your expected holding period.

Why do DeFi APYs change so rapidly?

DeFi APYs are determined by supply and demand in real time. When many users deposit into a lending pool, the interest rate drops because more lenders compete for fewer borrowers. When a liquidity mining program launches with high emissions, APY spikes; as more capital flows in chasing the yield, it dilutes among more depositors and the per-depositor APY falls. The best yields are often only available briefly, before capital rushes in to arbitrage them down.

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