Effective Annual Rate

The Effective Annual Rate represents the actual interest rate earned or paid on an investment or loan after accounting for the effects of compounding over a given period. Unlike a simple nominal rate, the Effective Annual Rate reflects the reality that interest is earned on previously earned interest, which is highly relevant in decentralized finance protocols where compounding occurs frequently.

For instance, a crypto staking protocol might quote a daily percentage yield, but the Effective Annual Rate will be significantly higher due to the compounding effect throughout the year. It provides a more accurate picture of the true cost of borrowing or the true return on investment.

Traders and liquidity providers use this metric to assess the real-world performance of yield-bearing assets. It is the gold standard for comparing the profitability of different financial products that offer varying compounding frequencies.