Anyone who has dealt with trading in traditional finance is likely to be aware of profit and loss (PnL). But is PnL in the cryptocurrency world the sa
Anyone who has dealt with trading in traditional finance is likely to be aware of profit and loss (PnL). But is PnL in the cryptocurrency world the same? The ability to comprehend terms like mark-to-market (MTM), realized PnL and unrealized PnL will help develop a better understanding of the cryptocurrency a person holds.
Without a well-defined process to get insight into profit or loss, cryptocurrency trading may be overwhelming, and traders may struggle with what they are doing. PnL reflects the change in the value of a trader’s positions over a specific period.
Understanding the basics of PnL
PnL in crypto refers to the calculation of the profit or loss made on a cryptocurrency investment or trading position. It is a metric used to evaluate the financial performance of a trader or investor in the crypto market.
To begin, here are some key terms in PnL terminology:
MTM
MTM refers to the process of valuing an asset or financial instrument based on its current market price or fair value. For example, in the context of crypto trading, if an investor holds a certain amount of Bitcoin (BTC), the value of that Bitcoin will fluctuate based on the current market price.
The general formula for calculating PnL is:
Suppose the MTM price for Ether (ETH) today is $1,970, while the MTM price yesterday was $1,950. In this case, the PnL is $20. It indicates a profit of $20. On the contrary, if the MTM price of ETH was $1,980 yesterday, it indicates a loss of $10.
Future value
Future value indicates the value of a digital coin at a future point in time.
For example, if a trader stakes Tron (TRX) worth $1,000 with a 4% yearly reward, how much will the person get back after a year? The answer is $1,040. At the time of staking, the present value will be $1,000, while the future value will be $1,040.
There will be a present value at the point when the trader stakes, but if the person considers the future as a whole, there could be countless future values.
There is a different way to use future value as well. Traders could ask how much to stake to get $1,040 in a year. If they know the present and future values, they could calculate the discount factor. The formula for calculating the discount factor is:
For the example given above, the discount factor will be:
Realized PnL
Realized PnL is calculated after traders have closed their position (sold the cryptocurrency they hold). Only the executed price of the orders is taken into account in realized PnL, and it has no direct relation to the mark price.
The mark price is the price 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 formula for realized PnL is:
An example will help understand how to calculate realized PnL. If the entry price for buying X number of Polkadot (DOT) is $70 and the exit price is $105, the PnL for the period is $35, which refers to a profit of $35. However, if the closing price of the trade was $55, the PnL will be $15, but it will reflect a loss.
Unrealized PnL
Unrealized PnL refers to the profit or loss that is currently held in open positions but has not yet been realized through closing the position. The formula for determining unrealized PnL is:
Donald has purchased ETH contracts with an average entry price of $1,900. The mark price of ETH is currently $1,600. The unrealized PnL for Donald is the difference between the average entry price and the mark price.
Unrealized PnL = $1,900 – $1,600 = $300
How to do PnL calculation
To determine PnL in cryptocurrency, a trader needs to find the difference between the initial cost of acquiring a digital coin and the current market value of the same coin. Various methods to calculate PnL in cryptocurrency are as follows:
First-in, first-out (FIFO) method
The FIFO method requires the seller to use the price of the asset from when it was first bought. Here is the process to calculate PnL using the FIFO method:
1) To settle on the initial cost of the cryptocurrency, multiply the purchase price per unit by the number of units sold.
2) To determine the current market value of the asset disposed of, multiply the current market price per unit by the number of units sold.
3) To find the PnL, deduct the initial cost from the current market value.
Suppose Bob first bought 1 ETH at $1,100 and a few days later bought 1 ETH at $800. A year later, he sold 1 ETH at $1,200. As he had first bought ETH at $1,100, this price will be considered the initial cost. Applying the FIFO method, Bob could calculate PnL as follows:
Bob’s initial cost = (1 ETH x $1,100) = $1,100
Current market value = (1 ETH x $1,200) = $1,200
PnL = $1,200 – $1,100 = $100 (profit)
Last-in, first-out (LIFO) method
The LIFO method requires the seller to use the most recent purchase price of an asset in the calculation. The other aspects are just like the FIFO method. Here is the PnL using the LIFO method using the same example as above:
Bob’s initial cost = (1 ETH x…
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