Annual Percentage Rate (APR) meaning

The annual percentage rate is the estimated interest rate an individual earns for lending their crypto assets. It can also refer to the amount a borrower pays per year relative to the total loan amount.

What Is the Annual Percentage Rate in Crypto?

When you deposit your money in a savings account, you expect to earn some interest from it after some time. Borrowing money from a financial institution also attracts some interest on the loan. The same applies to borrowing or lending cryptocurrency from a DeFi protocol. One of the most common financial metrics for representing yearly interest rates associated with borrowing and lending crypto is the annual percentage rate.

The annual percentage rate (APR) is the interest rate applied to the original sum of investment, deposit, or loan. Simply, it is the percentage an investor earns as interest for lending their crypto in decentralized finance (DeFi) protocols. 

Most exchanges typically offer high APR to incentivize users to stake their crypto. Some platforms also offer cryptocurrency loans at different rates –  fixed or flexible rates.

• Fixed lending – This involves locking your crypto for a specific amount of time at a fixed rate. Fixed lending often results in higher interest rates for the user.
• Flexible lending – Gives users the flexibility to withdraw their deposited cryptocurrency at any time. However, the returns are much lower than in fixed lending.

How Is APR Calculated?

While this metric takes into account the interest rates and additional fees associated with the loan, it excludes compound interest. This implies that APR focuses more on the cost of borrowing. This compound interest factor is what separates it from annual percentage yield (APY) – which reflects the true annual return since it factors in the compounding effect of compensation.

APR is often annualized, meaning that it is calculated yearly. If the original amount is held for less than a year, the interest rate is calculated for that specific period. Thus, APR is calculated as follows:

APR = [P * (1 + R * T)]

Where P is the principal amount (the initial capital or loan amount), R is the interest rate used, and T is the time in years.

For instance, assume that you deposit 1 ETH in a lending protocol that offers an APR of 20% per annum. If you lock your deposit for exactly one year, you’ll earn 0.20 ETH on your initial capital, making your total investment 1.2 ETH. However, if you hold it for 6 months, your total investment will be approximately 1.1 ETH.