Understanding and Calculating APY in Liquidity Pools

Detailed Instructions

To begin, you must gather the necessary data from the specific liquidity pool. This involves querying the pool's smart contract or using a blockchain explorer like Etherscan for Ethereum-based pools. The most critical data points are the total value locked (TVL) and the daily fee generation.

• Sub-step 1: Identify the Pool Contract Address. For example, use the Uniswap V3 USDC/ETH 0.05% pool at address 0x88e6A0c2dDD26FEEb64F039a2c41296FcB3f5640.
• Sub-step 2: Query for TVL. Use a block explorer or an API to find the current total value of assets locked in the pool, denominated in USD. For our example, let's assume a TVL of $10,000,000.
• Sub-step 3: Query for Daily Fees. Find the total fees collected by the pool over the last 24 hours. This often requires summing the swap event fees. Assume the pool generated $2,500 in fees yesterday.

Tip: For consistent calculations, ensure all values are converted to a stable currency like USD and that the time period for fees is exactly 24 hours.

Detailed Instructions

With the raw data collected, you can now calculate the daily yield rate. This is the foundational metric that shows the pool's earning power for a single day, before considering compounding. The formula is straightforward: Daily Yield = (Daily Fees Generated) / (Total Value Locked).

• Sub-step 1: Apply the Formula. Using our example numbers: Daily Yield = $2,500 / $10,000,000 = 0.00025.
• Sub-step 2: Convert to Percentage. Multiply the result by 100 to express it as a percentage: 0.00025 * 100 = 0.025%. This means the pool generated a 0.025% return on the TVL in one day.
• Sub-step 3: Verify the Calculation. Double-check your inputs. A common error is using weekly or annual fees by mistake. The daily yield should typically be a small decimal (e.g., 0.01% to 0.1% for major pools).

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// Example calculation in JavaScript
const dailyFees = 2500; // in USD
const tvl = 10000000; // in USD
const dailyYield = dailyFees / tvl; // Result: 0.00025
const dailyYieldPercent = dailyYield * 100; // Result: 0.025%

Tip: This daily yield is a snapshot and can be highly volatile. For a more stable estimate, consider using a 7-day or 30-day average of daily fees.

Detailed Instructions

The Annual Percentage Yield (APY) factors in compound interest, assuming all daily earnings are reinvested back into the pool. This creates an exponential growth effect. The standard formula is: APY = (1 + Daily Yield)^365 - 1.

• Sub-step 1: Use the Compounding Formula. Start with 1 (representing your principal), add the daily yield, raise it to the power of 365 days, and subtract the original principal (1). Using our daily yield of 0.00025: APY = (1 + 0.00025)^365 - 1.
• Sub-step 2: Perform the Calculation. First, calculate the base: 1.00025. Then, raise it to the 365th power. The result is approximately 1.0954. Finally, subtract 1: 1.0954 - 1 = 0.0954.
• Sub-step 3: Convert to Percentage. Multiply by 100: 0.0954 * 100 = 9.54% APY. This is significantly higher than the simple annual rate of 0.025% * 365 = 9.125%, demonstrating the power of compounding.

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// JavaScript calculation for APY
const dailyYield = 0.00025;
const apyDecimal = Math.pow(1 + dailyYield, 365) - 1; // Result: ~0.0954
const apyPercent = apyDecimal * 100; // Result: ~9.54%

Tip: Always confirm if a quoted APY is for simple interest (APR) or compound interest (APY). In DeFi, APY is the standard and more accurate metric for potential earnings.

Detailed Instructions

The raw APY calculation presents a gross figure. To estimate your net return, you must consider impermanent loss (IL) and gas costs for adding/removing liquidity and claiming rewards. Impermanent loss occurs when the price ratio of your deposited assets changes compared to when you deposited them.

• Sub-step 1: Estimate Impermanent Loss. Use an online IL calculator. For a 50/50 pool like USDC/ETH, if ETH price increases 50% after you deposit, your IL could be roughly -2.5% of your portfolio value compared to just holding the assets. This effectively reduces your APY.
• Sub-step 2: Factor in Gas Fees. Calculate the cost of your transactions. For example, adding liquidity on Ethereum might cost $30 in gas, and claiming fees/removing liquidity might cost another $50 each. If your total invested capital is $5,000, these one-time costs represent a 1.6% drag on your principal.
• Sub-step 3: Calculate a Net APY Estimate. A simplified net APY could be: Net APY ≈ Gross APY - (Estimated Annualized IL %) - (Gas Costs / Principal / Investment Period in years). If gross APY is 9.54%, IL is 2.5%, and you invest for one year with $80 gas on $5,000 principal, net APY ≈ 9.54% - 2.5% - (80/5000/1) = 9.54% - 2.5% - 1.6% = 5.44%.

Tip: Impermanent loss is only "impermanent" if prices return to your entry point. If you withdraw at a different ratio, the loss becomes permanent. Always model different price movement scenarios.