How DeFi yield is calculated
DeFi protocols quote returns in two ways, and the difference matters. APR is the simple annual rate with no compounding assumed. APY assumes the yield is harvested and redeposited at a stated frequency, so it compounds. The same underlying return produces a higher APY than APR, and the gap widens as the rate rises and the compounding interval shortens.
The more important question is where the yield comes from, because that determines whether it can last. There are only three real sources: interest paid by borrowers, trading fees paid by people using a pool, and newly issued protocol tokens. The first two are payments from someone with a reason to pay. The third is not.
Emission-funded yield is the one to scrutinise. When a protocol pays depositors in a token it prints, the headline rate can be enormous while the economic return is whatever that token is worth once emissions stop or once everyone earning it sells. A high advertised APY funded entirely by emissions is a marketing number, not an income stream.
Worked example
A deposit of 10,000 into a position quoting 20% APR, shown at two compounding frequencies.
| Input | Value |
|---|
| Deposit | 10,000 |
| Quoted APR | 20% |
| APY if compounded monthly | 21.94% |
| APY if compounded daily | 22.13% |
| Value after 1 year (daily) | 12,213 |
| Gain over simple 20% APR | 213 |
| Cost of 365 compounding transactions at 5 each | 1,825 |
The last two rows are the ones people skip. Compounding daily instead of taking simple interest adds 213 — but doing it requires 365 transactions, and at 5 in gas each that costs 1,825. On a position this size, compounding daily destroys roughly eight times more value than it creates. Optimal compounding frequency depends on position size and transaction cost, not on what maximises the number in the formula.
How to use this calculator
- Check whether the quoted figure is APR or APY before comparing anything — comparing one protocol's APY against another's APR overstates the difference.
- Find out what actually funds the yield. Split it into the portion from interest or fees and the portion from token emissions, and treat those two components as having entirely different reliability.
- Enter a realistic compounding frequency given transaction costs, not the maximum theoretically possible.
- Subtract every cost: deposit and withdrawal gas, performance fees, and the price impact of selling reward tokens.
- Compare the net figure against what you could earn with materially less risk before concluding that the yield is attractive.
Frequently asked questions
What is the difference between APR and APY?
APR is the simple annual rate with no compounding. APY assumes earnings are reinvested at some frequency, so it compounds and is always the higher number for the same underlying return. Protocols tend to advertise whichever is larger, which is why checking the label before comparing is essential.
Why are some advertised yields so high?
Almost always because they are paid in a newly issued protocol token rather than in revenue. The rate is calculated at the token's current price, and it falls as emissions dilute supply and recipients sell. A yield that only exists while a token is being printed is a subsidy to attract deposits, not a return on capital.
What is impermanent loss and does it apply here?
It applies to any yield earned by providing liquidity to an automated market maker. If the two assets in a pool move apart in price, the value of your share ends up below simply holding them. Fee income must exceed that gap for the position to have been worthwhile at all.
What are the main risks in a DeFi yield position?
Smart contract failure or exploit, liquidation if the strategy involves borrowing, impermanent loss in liquidity pools, protocol insolvency if bad debt exceeds reserves, and the collapse of the reward token itself. These are additive — a strategy layering several protocols inherits every risk in the chain.
How often should I compound?
Only until the marginal gain exceeds the transaction cost. On a small position with meaningful gas costs, the optimum may be a few times a year or never. Auto-compounding vaults amortise the cost across many depositors, which is their main advantage — at the price of an additional contract to trust.
Is a stablecoin yield low risk?
Lower price risk, not low risk. You still carry smart contract risk, protocol insolvency risk and the risk that the stablecoin itself depegs. A double-digit yield on a stablecoin is a signal that someone is being paid to accept a risk that has not yet materialised — the question is which risk.
This calculator is an educational tool. Results are estimates based on the inputs you provide and do not constitute financial advice. Verify figures with your bank, broker or a qualified advisor before acting on them.