- APY breakdown of what it really means for your earnings
- Why high APYs can be used to mislead or entice novice crypto investors
- How to avoid falling for the trap of an overinflated APY
One of the biggest challenges that DeFi currently faces is its reputation. Rather than a financial system that rivals the traditional method of banking, DeFi is often portrayed as a casino-style method of getting rich quickly.
The absurdly high crypto APY (annualized percentage yield) offered across L1s plays a large part in earning this reputation.
We are going to break down the truth behind these sky-high APYs, and explain exactly what these numbers mean. First we’ll explain what an APY actually is (compared with APR), and then go through how these yields often play out in reality.
This should give our users an idea of the value behind the steady return offered by Meta Pool, and help them approach DeFi platforms more informed.
Annualized Percentage Yield (APY) Explained
Since the inception of financial instruments, annualized percentage yield has been the benchmark measure of an investment’s return. APY is the total amount earned on an investment, expressed as a percentage over an entire year, taking into account the effect of compounding interest (whereas the APR – Annual Percentage Rate – does not include any compounding effect on your deposits).
For example, let’s take an initial investment or deposit of $1000 in a DeFi protocol, say a staking protocol. Assume that this protocol generates staking rewards every 12 hours at a rate of 0.0135% and has a compounding effect.
Based on the following APY formula, that latter means you get an APY of roughly 10.35%
- r = % rate for the period (in our example 0.0135%)
- n = number of compounding periods (in our example 365 x 2 – because it is every 12h)
So, coming back to your initial investment of $1000, after 12 months you will have $1103.56.
So far so good, nothing really complicated here. And since the first staking project launched, DeFi has followed the market, using APY to advertise their rates of return.
While this standardization is necessary and useful for comparing investment opportunities, predicting returns in DeFi in terms of years is often misleading.
Why is that? The dodgy aspect of high crypto APY comes in when these APY are bound to a specific time window, or are variable.
Time-bound High Crypto APY
Most web3 platforms offer yield farms, staking periods, or other investment devices in periods of weeks or months due to the market volatility.
If the same example investment of $1000 instead grew to $1100 in a month, it would have an APY of 214%. At 2 weeks – the preferred period of the most popular protocols on DeFi today – APY of 1,102%. This would be like weighing a 10kg dog and saying it’s 10,000 grams.
An experienced investor could see through a high APY just by looking at them, but it is important for retail DeFi users to understand the math behind these formulas.
Unfortunately, short time frames are just the beginning of how APY relates to real earnings.
Variable High Crypto APY & Liquidity Pools
Understanding the time-bound aspect of APY is important, but there are other factors that further determine what APY means for the end user.
Both the type of rewards earned & TVL (Total Value Locked) will affect the announced APY you are considering. Depending on these factors, the actual earned APY for a user in these pools can dramatically decrease.
Let’s have a look a the impact of TVL on the APY. Usually, liquidity pools and staking incentives are usually advertised at their start, when there are none or few participants and the added rewards are concentrated among a certain few. Thus a very high crypto APY advertised!
Of course, the more new investors get in on the project, the lower the APY number since the pie has to be sliced thinner and thinner, but this is how gigantic APYs are pushed forward to the first liquidity providers.
The only way to maintain the APY would be for the LP owner to constantly add more rewards. But this generates significant pressure on the FIAT value of the token in the long term as well as raises question on the usefulness and healthiness of the related project…
A Short Example
Take the example of an APY of 328% advertised at the beginning of a liquidity pool with a starting TVL of $500,000. Many users hear of the great return and enter the pool, raising the TVL to $5,000,000. In this case, the APY would now be 43%, even if the pool was entered right away
Unlike the stock market, there are no discrete shares of a liquidity pool; rewards are based on the percentage of the pool you own. DeFi platforms get to decide how often their posted APY refreshes leaving users at the mercy of the market to predict their returns
The Tokenomics Behind High Crypto APY
An additional factor that impacts the value of your rewards earned is the token your rewards are paid in. Platforms often pay staking rewards in a token other than the blockchain’s native token being staked.
APY is also calculated assuming the price of a token at the beginning of the period. This means that as rewards are accrued, more tokens must be minted to pay out rewards, inflating the token and lowering the real APY.
While the token itself is being accrued at a steady rate according to the APY, a single project can dramatically increase its token’s circulating supply by paying these rewards. The result is that the token decreases in value, and your rewards are ultimately worth less than they were before. That situation is even amplified in a bear market!
For example, Meta Pool’s staking rewards are paid in $NEAR, which is comparably a much more stable asset than an individual project’s token. This means that you are open to broader price action on the NEAR token itself, but also have almost no risk of rewards paid dictating the price of your reward asset.
In sum, a high crypto APY is not as enticing as it may seem at a glance. While Degens and other highly experienced crypto traders can indeed turn a profit by moving liquidity between high APY pools, its much more likely that you will not earn the return you had hoped for.
In general, if a protocol offers high returns, it’s important to understand that it will become less lucrative over a period of time due to inflation. Additionally, given the nascent stage of many of these projects, they are inherently on the (very) riskier side. The crazier the yield, the riskier the project.
Meta Pool offers a platform that can guarantee the same staking reward as the native NEAR wallet, plus the ability to keep your assets liquid. In addition, we pay our rewards in NEAR – which means you aren’t betting on a small project’s token.
With all this in mind – Keep on Staking!
About Meta Pool & stNEAR
Meta Pool is the leading liquid staking solution for $NEAR and wNEAR token holders. With Meta Pool you earn NEAR staking rewards and maintain your liquidity to participate in DeFi protocols on NEAR and Aurora.
Users staking $NEAR and wNEAR with Meta Pool receive in exchange stNEAR (staked NEAR) tokens.
stNEAR simultaneously accrues staking rewards and unlocks users’ liquidity enabling them to participate in DeFi activities (e.g. lending, farming, borrowing) on NEAR and Aurora.
Stake $NEAR on Meta Pool
Go DeFi on NEAR & Aurora
More APY and more rewards
Meta Pool also solves the problems associated with Proof-of-Stake networks staking: illiquidity, immovability and accessibility. Meta Pool also aims to distribute staking in multiple validators to improve censorship-resistance of the NEAR network.
With a TVL of ~9 Million $NEAR and growing, Meta Pool has become in just a few months a cornerstone element of the NEAR ecosystem. Meta Pool is making NEAR Protocol more decentralized and therefore more secure.
In February 2022 Meta Pool has been successfully audited by BlockSec, confirming the implementation of the highest security standards.
For more information visit https://metapool.app.