Profit and Loss (PnL) calculations are as important in cryptocurrency trading as they are in traditional finance. Beginners entering the crypto world often struggle with understanding the different types of PnL and how to calculate them for accurate financial evaluation. This article aims to provide a comprehensive guide on PnL in cryptocurrency trading.
PnL in Crypto
PnL in cryptocurrency trading refers to calculating the profit or loss made on an investment or trading position. It is a crucial metric used to evaluate the financial performance of a trader or investor in the crypto market.
Mark-to-market (MTM) refers to the process of valuing an asset based on its current market price or fair value. For example, if an investor holds a certain amount of Bitcoin (BTC), the value of that Bitcoin will fluctuate based on the current market price. The PnL formula for MTM is:
PnL = (MTM price today – MTM price yesterday)
Future value refers to the value of a digital coin at a future point in time. For instance, if a trader stakes Tron (TRX) worth $1,000 with a 4% yearly reward, the future value after a year would be $1,040. There could be countless future values of a cryptocurrency, and traders could use future value calculations to figure out how much to stake to obtain a specific future value.
Realized PnL is calculated after closing a position. The executed price of orders is taken into account in realized PnL, and it has no direct relation to the mark price. The mark price is the value at which a derivatives contract is valued based on the current market price of the underlying asset, rather than the price at which the contract is being traded. The realized PnL formula is:
Realized PnL = (selling price – buying price)
Unrealized PnL refers to the profit or loss held in open positions that has not been realized through closing the position. The formula for determining unrealized PnL is:
Unrealized PnL = (average entry price – mark price)
Traders can use various methods to calculate PnL in cryptocurrency trading depending on their needs and preferences. These include:
First-in, First-out (FIFO) Method
The FIFO method requires sellers to use the price of an asset when it was first bought. The FIFO PnL calculation process includes:
1. To settle on the initial cost, multiply the purchase price per unit by the number of units sold.
2. To determine the current market value, multiply the current market price per unit by the number of units sold.
3. To calculate the PnL, deduct the initial cost from the current market value.
Last-in, First-out (LIFO) Method
The LIFO method requires sellers to use the most recent purchase price of an asset for the PnL calculation. The process is similar to the FIFO method.
Weighted Average Cost Method
The weighted average cost method requires traders to determine the average cost of all units of a digital currency in their portfolio to arrive at the initial cost. The PnL calculation process includes:
1. Determine the total cost of all units of the cryptocurrency. Multiply the purchase price per unit for each transaction by the number of units of the asset and add the numbers.
2. To arrive at the weighted average cost per unit of the digital coin, divide the total cost of all units by the number of units.
3. Find the current market value of the cryptocurrency sold. Multiply the current market price per unit by the number of units sold.
4. To determine PnL, subtract the average cost per unit from the current market value.
Profits/Losses from Opening and Closing Positions
Analyzing open and closed positions at regular intervals is an efficient way to monitor cryptocurrency trading performance. An initial purchase in the market is an open position, while selling the cryptocurrency is called closing the position. Regular analysis of trades in line with open and closed positions helps traders trade in an organized manner.
Year-to-Date (YTD) Calculation
YTD calculation is a way to measure the performance of investments made in cryptocurrency from the start of the year to the current date. Investors who regularly buy and hold cryptocurrencies for years can know their unrealized profits with a YTD calculation. The trader needs to calculate the value of the portfolio at the beginning and end of a year and compare these values.
A transaction-based calculation requires a person to calculate the PnL for each specific transaction. For instance, if a person bought 1 ETH for $1,000 and sold it for $1,500, the PnL for the transaction would be $500 profit ($1,500 – $1,000).
In conclusion, having a well-defined process to understand profit or loss is crucial in cryptocurrency trading. The ability to comprehend terms like mark-to-market (MTM), realized PnL, and unrealized PnL will help traders develop a better understanding of the cryptocurrency they hold. By evaluating their PnL regularly, traders can monitor their progress and make informed decisions about future investments.