Open any DeFi yield aggregator and look at the APYs. You'll see 150%, 8,420%, even 42,069% APY. Now here's reality: if you deployed money into that 150% APY pool for a year, you'd likely earn somewhere between -20% and +40% after token price dumps, impermanent loss, gas fees, and the fact that the APY changed 50 times. APY in crypto stands for "annual percentage yield," but it might as well stand for "annualized ponzi yield" because the displayed number is often completely disconnected from what you'll actually earn.

APY represents the projected yearly return including compound interest. In traditional finance, 5% APY means you'll earn almost exactly 5% over a year. In crypto, APY is displayed the same way but means something very different: it's a snapshot that could change dramatically, often includes token rewards that may crash, and rarely accounts for impermanent loss that can turn "200% APY" into a net loss.

The number you see is technically accurate at that moment—if conditions remained constant for a full year and you compounded regularly, you'd earn that APY. But conditions never remain constant. Rates fluctuate hourly. Token prices crash. What you actually earn rarely matches what the protocol displayed.

APY vs APR—the compounding difference

APY (annual percentage yield) includes compound interest, while APR (annual percentage rate) doesn't. If you earn 10% APR and compound monthly, your APY is about 10.47% because you're earning interest on your interest.

In DeFi, protocols show whichever number looks bigger. "100% APR" sounds less impressive than "171% APY" even though they're the same if you compound continuously. The fundamental issue is that neither accounts for token price changes. If you're earning 200% APY in a governance token that crashes 80%, your real return is deeply negative.

How DeFi calculates those insane APYs

When you see 1,000% APY, here's what's happening: base yield from actual activity is maybe 5-15% APY. Then the protocol adds token rewards—50,000 governance tokens per day. At current token prices, that's an additional 985% APY.

The math is technically correct at that moment. But the token price won't stay constant. It'll probably crash as farmers receive tokens and immediately sell them.

This is how DeFi summer 2020 happened: protocols offered 5,000-10,000% APYs, farmers rushed in and sold immediately. Token prices crashed 90% within weeks. Early farmers made fortunes. Late arrivals got wrecked.

Real yield vs nominal yield—the critical distinction

Real yield comes from actual protocol revenue: trading fees, interest from borrowers, transaction costs. This is sustainable because it's not dilutionary. Protocols like GMX pioneered this, distributing trading fees in ETH and USDC to stakers.

Nominal yield includes token emissions. A protocol printing tokens inflates APYs but dilutes existing holders. If everyone earns 200% APY in tokens and supply inflates 200%, nobody gained value.

Most DeFi yields are nominal. Sustainable yields come from real revenue: 3-8% on stablecoin lending, 5-15% from DEX fees, 3-5% from ETH staking. Boring compared to 500% APY, but actually achievable.

Red flag: any pool showing 100%+ APY on established assets. If USDC lending shows 150% APY, that's subsidized by token emissions that will crater.

Impermanent loss—the yield killer nobody talks about

AMM pool APYs almost never account for impermanent loss, which can obliterate your yields.

A pool shows 40% APY from fees and rewards. You deposit ETH and USDC. ETH doubles in price. You earned 40% APY in fees but lost 25% to impermanent loss because the AMM sold your ETH as it appreciated. Your actual return: 15% gain, when holding ETH alone would have given you 100%.

Impermanent loss is a silent tax the displayed APY ignores. Protocols show gross yields (what you earn in fees) not net yields (what you earn after IL). For volatile pairs, IL often exceeds fee earnings, meaning real APY is negative even though the protocol shows positive.

Stablecoin pools avoid this since prices don't diverge much. A Curve stablecoin pool showing 8% APY will probably deliver close to 8%. But an ETH/altcoin pool showing 60% APY might deliver -10% after IL wrecks you.

Gas fees—the hidden drag on small positions

If you're yield farming $5,000 on Ethereum mainnet at $50 per transaction: deposit costs $50, claiming and compounding weekly costs $50 x 52 = $2,600/year, exit costs $50. That's $2,700 in gas to farm $5,000.

At 30% APY, you'd earn $1,500 in a year. After gas, you're down $1,200. The displayed APY says 30%, your realized return is -24%.

This is why farming small amounts on Ethereum mainnet is economically irrational. Layer 2s solve this with $0.01-1 transactions, making farming viable for normal-sized positions. But displayed APYs never include gas costs.

The variable rate problem

Traditional finance APYs are stable. Crypto APYs change hourly, sometimes dramatically.

DeFi lending rates fluctuate with utilization—dropping from 8% to 3% overnight when demand falls. Liquidity mining is worse. Protocol launches with 500% APY. Everyone rushes in, diluting rewards to 100%. Token price crashes, effective APY drops to 20%. You deposited at "500% APY" but earned closer to 50% average.

APY is marketing, not a contractual promise.

How to actually evaluate crypto yields

Separate real from nominal: Is the yield from actual revenue or token emissions? Real yields of 5-15% are sustainable. Nominal yields of 100%+ aren't.

Check token economics: Will governance tokens hold value? Do they have utility or are they farm-and-dump?

Calculate after IL: For LP positions, what's realistic IL if prices move? Stablecoin pools have minimal IL risk. Volatile pairs often have IL exceeding yields.

Factor gas costs: For smaller positions, mainnet gas destroys returns. Use Layer 2s where gas is pennies.

Assess sustainability: Can this protocol generate enough revenue to sustain these yields? Aave paying 6% on USDC from organic demand is sustainable. New protocols offering 300% APY from emissions are not.

Realistic yield expectations

Sustainable yields: stablecoin lending 3-10% APY, ETH staking 3-4% APY, stablecoin LP pools 5-12% APY, blue-chip DEX LPs 10-30% APY, real yield protocols 8-25% APY.

Boring numbers, but actually achievable. If you're consistently earning 8-15% on stablecoins or 15-30% on blue-chip LPs, you're doing well.

Anything significantly higher is probably temporary incentives, unsustainable emissions, or misleading numbers ignoring IL.

The honest take on crypto APY

APY in crypto is simultaneously useful and completely misleading. Useful for comparing opportunities. Misleading because the displayed number rarely matches realized returns after token price changes, impermanent loss, gas fees, and rate fluctuations.

Treat displayed APYs as rough estimates, not promises. A pool showing 50% APY might realistically deliver 20-70% depending on conditions.

For conservative DeFi users, ignore anything above 15-20% APY. Stick to real yields from established protocols: stablecoin lending, ETH staking, blue-chip LP positions. These won't make you rich overnight, but they consistently deliver.

For degens, high APYs are opportunities to extract value then exit. Farm the 500% APY pool, sell the tokens immediately, compound into stablecoins, repeat. This requires understanding you're playing musical chairs.

The biggest mistake is seeing "200% APY" and thinking it's like a savings account. It's not. It's highly variable, token-emission-driven, and will probably disappoint. Approach crypto APYs with skepticism, understand what drives the yield, and plan for lower returns.

At least crypto displays the APY. Traditional finance buries returns in fine print. DeFi's transparency is better—you just need to understand what you're looking at.

Further Reading:

• APY vs APR Explained - Understanding the compounding difference
• Real Yield - Messari Research - Analysis of sustainable protocol yields
• DeFi Llama Yields - Real-time APY data across all DeFi protocols
• Impermanent Loss Calculator - Calculate IL impact on APY
• Aave Interest Rate Model - How lending APYs are calculated
• Yearn Vault Strategies - Auto-compounding APY optimization
• Token Terminal - Protocol Revenue - Real revenue vs token emissions
• CoinGecko Yield Farming - APY comparison across platforms
• Curve Pool APYs - Breakdown of fees vs incentives
• Bankless - Yield Strategies - Analysis of sustainable DeFi yields