APY (Annual Percentage Yield)
In simple terms
APY shows what a rate would grow to over a year if every payout were immediately reinvested. It is always the flattering way to present a yield, because compounding is baked into the number.
Definition
A yield figure that assumes returns are reinvested and compounded over a year.
In depth
APY converts a periodic rate into an annualised figure including compounding: for a periodic rate r compounded n times, APY equals (1 + r/n)^n − 1. In DeFi the quoted APY is frequently an extrapolation of a very recent window — sometimes the last few hours — projected across a year, which is why it can read in the hundreds or thousands of percent. It may also be paid partly in a protocol's own governance token, in which case the realised return depends on that token's price at the moment of sale rather than on the advertised rate.
How does APY (Annual Percentage Yield) work?
A protocol measures the rate earned over a recent period, annualises it, and applies a compounding assumption. The figure then updates continuously as rates change. Realising anything close to it requires the rate to persist for a year, the reinvestment to actually happen at the assumed frequency, and any token component to hold its value — three conditions that rarely all hold.
An example
A pool advertises an illustrative 40 percent APY. Half is paid in the protocol's own token, which falls 60 percent over the period. The realised return is a fraction of the headline, and if fees and gas costs are counted it can be negative even though the advertised rate never changed.
Figures are illustrative only.
What beginners get wrong
- Treating APY as a promise. It is a projection from recent conditions, not a rate anyone has committed to.
- Ignoring what the yield is paid in. A high rate paid in a falling token is not a high return.
- Assuming compounding happens automatically. If claiming and reinvesting is manual, the realised figure is the APR, not the APY.
- Forgetting transaction costs. On a small position, the fees to enter, claim and exit can exceed a year of yield.
Related terms
Part of
What is DeFi, and how does decentralized finance work? — the subject page for defi, with all 18 of its definitions in one place.
Educational only — not financial advice.