Anyone who trades in traditional finance is likely to be aware of profit and loss (PNL). But is PNL the same in the cryptocurrency world? The ability to understand terms such as mark-to-market (MTM), realized PnL, and unrealized PnL can help a person better understand the cryptocurrency they hold.
Without a well-defined process to gain insight into profit or loss, cryptocurrency trading can become overwhelming and traders can struggle with what they are doing. PnL reflects the change in value of a trader’s positions over a period of time.
To get a clear understanding, let’s examine this in the context of cryptocurrency trading.
Understand the basics of PnL
PNL in crypto refers to the calculation of profit or loss 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 get started, here are some key terms in PnL terminology:
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
, the value of that bitcoin will fluctuate based on the current market price.
The general formula for calculating PnL is:
Assume the MTM price of Ether
Today is $1,970, while the MTM price was $1,950 yesterday. In this case, PnL is $20. This represents a profit of $20. Conversely, if ETH’s MTM price was $1,980 yesterday, that would indicate a loss of $10.
Future value refers to the value of a digital coin in the future.
For example, if a trader stocks Tron
How much will a person with $1,000 worth return after one year with a 4% annual reward? The answer is $1,040. At the time of stacking, the present value will be $1,000 and the future value will be $1,040.
There is a present value at the time the trader buys the stock, but if the individual considers the future as a whole, there can be countless future values.
There is another way to use future value. Traders can ask how many shares they need to get $1,040 in a year. If they know the present and future values, they can calculate the discount factor. The formula for calculating the discount factor is:
In the example given above, the discount factor would be:
Realized PNL is calculated after traders have closed their position (sold their cryptocurrency holdings). Realized PnL takes into account only the executed price of the orders, which is not directly related to the mark price.
The mark price is the value of a derivative contract based on the current market price of the underlying asset rather than the price at which the contract trades.
The recognized PNL formula is:
An example will help to understand how to calculate the realized PNL. If the entry price for buying X number of polkadots
is $70, the exit price is $105, and the PnL for the period is $35, indicating a profit of $35. However, if the closing price of the trade was $55, the PnL would be $15, but that would reflect the loss.
Unrealized PNL refers to the profit or loss on currently open positions, but not yet realized by closing the position. The formula for determining unrealized PnL is:
Donald has bought ETH contracts with an average entry price of $1,900. The mark price for ETH is currently $1,600. Donald’s unrealized PnL is the difference between the average entry price and the markup 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. Following are the various methods of calculating PNL in cryptocurrency:
First-in, first-out (FIFO) method
The FIFO method requires the seller to use the cost of the asset since it was first purchased. Here is the process for calculating PnL using FIFO method:
1) Multiply the purchase price per unit by the number of units sold to settle on the initial cost of the cryptocurrency.
2) To determine the current market value of the asset being sold, multiply the current market price per unit by the number of units sold.
3) To find PnL, subtract the initial cost from the current market value