What Is APY?
APY (Annual Percentage Yield) is the effective annual return on an investment when compound interest is factored in — interest earning interest. It's always equal to or higher than the equivalent APR because compounding adds additional returns. In DeFi, APY assumes you reinvest (auto-compound) your earned rewards.
How APY Works
The formula: APY = (1 + APR/n)^n - 1, where n is the number of compounding periods per year. At 100% APR compounded daily (n=365), the APY is 171.5%. At extreme DeFi rates, the difference is dramatic: 1,000% APR compounded daily yields an APY above 2 million percent — which is why some protocols advertise eye-popping numbers.
Why It Matters for Traders
Extremely high APYs in DeFi are almost always unsustainable and often indicate high risk — either the underlying token is inflationary (you earn tokens that lose value), the yield is subsidized (venture capital burning money for user acquisition), or the protocol carries smart contract risk. Always evaluate the source of yield: if you can't identify where the returns come from, you're likely the exit liquidity.
How It Shows Up for Perps Traders
Even if you mainly trade CEX perps, apy still matters when you hedge with spot, move collateral across chains, or compare DEX perps funding to CEX funding. Thin pool depth and oracle lag can widen the gap between the index you hedge and the book you trade.
Formula and Worked Example
Example numbers only (not a live quote).
Suppose you compare a spot bag and a short perp hedge. If the hedge notional is $5,000 and the spot bag drifts 2% while the hedge mark moves 1.2%, the residual basis is 0.8% of notional, or $40 on that $5,000 book. That gap is the cost of an imperfect hedge, separate from funding.
Common Mistakes
- Treating a single print of apy as a trade signal without checking funding, open interest, and your liquidation price.
- Mixing venue conventions (coin-margined vs USDT-margined, cross vs isolated) and reading the wrong mark.
- Copying example numbers from a glossary into live size without checking the current book depth and fee schedule.
- Ignoring related terms that change the meaning of the print on a given day.
