Profit and Loss (PnL) is a crucial concept in both traditional finance and the world of cryptocurrency trading. However, understanding PnL in the cryptocurrency market requires familiarity with terms like mark-to-market (MTM), realized PnL, and unrealized PnL. These terms play a significant role in evaluating the financial performance of traders and investors in the crypto market.
In the context of cryptocurrency trading, PnL refers to the calculation of profit or loss made on a cryptocurrency investment or trading position. It serves as a metric to assess the financial performance of individuals in the crypto market.
To grasp the basics of PnL, it is essential to understand key terms associated with it:
MTM is the process of valuing an asset or financial instrument based on its current market price or fair value. In the context of crypto trading, the value of a cryptocurrency like Bitcoin (BTC) fluctuates based on the current market price.
The general formula for calculating PnL is:
PnL = MTM price today – MTM price yesterday
For example, if the MTM price of Ether (ETH) today is $1,970 and the MTM price yesterday was $1,950, the PnL would be $20, indicating a profit. Conversely, if the MTM price of ETH was $1,980 yesterday, it would indicate a loss of $10.
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, they would receive $1,040 after a year. The present value at the time of staking would be $1,000, while the future value would be $1,040.
There is another way to use future value. Traders can calculate the amount to stake to achieve a specific future value. By knowing the present and future values, they can calculate the discount factor using the formula:
Discount factor = Future value / Present value
To illustrate, let’s say the present value of an investment is $1,000 and the future value desired is $1,040. The discount factor would be 1.04.
Realized PnL is calculated after traders close their positions by selling the cryptocurrency they hold. It takes into account only the executed price of the orders and has no direct relation to the mark price.
The formula for calculating realized PnL is:
Realized PnL = Exit price – Entry price
For example, if the entry price for buying Polkadot (DOT) is $70 and the exit price is $105, the PnL for the period would be $35, indicating a profit. However, if the closing price of the trade was $55, the PnL would be $15, reflecting a loss.
Unrealized PnL refers to the profit or loss held in open positions that have not yet been realized through closing the position. It is calculated using the formula:
Unrealized PnL = Average entry price – Mark price
For instance, if someone purchased ETH contracts with an average entry price of $1,900 and the mark price of ETH is currently $1,600, the unrealized PnL would be $300 ($1,900 – $1,600).
Calculating PnL in cryptocurrency involves finding the difference between the initial cost of acquiring a digital coin and its current market value. There are various methods to calculate PnL:
1. First-in, first-out (FIFO) method: This method uses the price of the asset from when it was first bought. The process involves multiplying the purchase price per unit by the number of units sold to determine the initial cost. The current market value of the asset disposed of is obtained by multiplying the current market price per unit by the number of units sold. Finally, the PnL is calculated by deducting the initial cost from the current market value.
2. Last-in, first-out (LIFO) method: This method uses the most recent purchase price of an asset in the calculation. The steps are similar to the FIFO method.
3. Weighted average cost method: This method requires determining the average cost of all units of a digital currency in the portfolio. The total cost of all units is calculated by multiplying the purchase price per unit for each transaction by the number of units and adding them up. The average cost per unit is obtained by dividing the total cost by the number of units. The current market value of the cryptocurrency sold is determined by multiplying the current market price per unit by the number of units sold. Finally, the PnL is calculated by subtracting the average cost per unit from the current market value.
Analyzing open and closed positions at regular intervals is an effective way to monitor performance. An initial purchase in the market represents an open position, while selling the cryptocurrency represents closing the position. By regularly analyzing trades in line with open and closed positions, traders can maintain an organized approach to trading.
Year-to-date (YTD) calculation is a method to measure the performance of investments made in cryptocurrency from the beginning of the year to the current date. Investors who hold cryptocurrencies for extended periods can assess their unrealized profits with a YTD calculation. By comparing the portfolio’s value at the start and end of a year, traders can determine their unrealized profits.
Transaction-based calculation involves calculating the PnL for each specific transaction. This method is suitable for traders with a small number of transactions.
The percentage profit method represents the PnL as a percentage of the initial cost. To calculate the percentage profit, traders divide the PnL by the purchase price and multiply the result by 100.
It’s important to note that these examples are simplified and do not take into account factors like taxes, trading fees, and market volatility. In real-life situations, traders must consider these factors when calculating PnL.
When calculating PnL for perpetual contracts, which are futures contracts without fixed settlement times or expiration dates, traders need to calculate both realized and unrealized PnL. The total PnL is obtained by adding these two values. Factors like trading fees and funding rates should be considered in real-life scenarios.
Understanding PnL in cryptocurrency trading is crucial for evaluating the profitability of one’s portfolio. It allows traders to assess the efficiency of their strategies and make informed decisions. Various tools, such as specialized spreadsheets and automated trading bots, can assist traders in analyzing their performance and identifying profitable trading opportunities.