If you have handled trading in traditional finance, then you may be aware of profit and loss (PNL). However, you may wonder if the PNL function in traditional cryptocurrency is the same in cryptocurrency. Well, generally, PNL is used to calculate the performance of investments, irrespective of whether they are from cryptocurrencies, the traditional stock market, or any other kind of asset. The fundamental concept of PNL is the same for both crypto and finance, with the major disparities being the method by which it is calculated. Let’s take a look at what is PNL in Crypto and how to Calculate it
What Does PNL Mean in Crypto?
PNL is short for Profit and Loss, and it is a word that is used to portray the total amount of money that a crypto trader has earned or lost while trading a specific cryptocurrency.
PNL is a very important tool for crypto traders because it reveals to them how much cash they have gained or lost on a specific trade. Also, it gives them an understanding of how well the trading strategies they applied are performing. This can help to influence their future trading decisions.
A positive PNL implies that the crypto trader has made a gain, on the other hand, a negative PnL implies that the crypto trader has lost money. For cryptocurrency traders, the PNL tool can help define the general performance of all their trading strategies. By keeping track of their PNL over time, crypto traders can easily recognize patterns in their trading and modify their trading strategies accordingly. This will help them maximize their gains and reduce their losses.
Is PNL in Crypto the Same as Profit and Loss in Traditional Trading?
Generally, PNL in crypto is pretty similar to the regular Profit and Loss in traditional finance. The major difference is just in the frequency at which traders calculate and report it. Usually, traders in the crypto market use this tool more frequently, as they need to make decisions fast due to the dynamic and very volatile nature of crypto markets. Hence, every crypto trader should have an understanding of PNL, regardless of their level of experience.
Why is PNL Calculation Important?
Still on the subject – what is PNL in Crypto and how to Calculate it – but answering the latter part, the PNL Calculation helps determine profit and loss. Also, this formula provides insight into the general performance of the crypto trader’s investments over a period. By considering the quantity, cost basis, and price of each crypto trade, you can easily estimate the profitability of your crypto trading strategies and modify them accordingly.
Realized PNL
Realized PNL is estimated after crypto traders have already closed their position (sold off the tokens they hold). Only the completed price of the orders is considered in realized PNL, hence, it has no direct association with the mark price.
The mark price is simply the price at which a specific derivatives contract is valued dependent on the current market price of the underlying asset instead of the original price at which the derivative contract is being traded.
The formula for realized PL is:
Realized PNL = Entry price – Exit price
For instance, if the entry price for buying X number of Ethereum (ETH) is $70 while the exit price is $100, and then the realized PNL is $30, which refers to a gain of $30. However, if the closing price of the crypto trade was $50, the PNL would be $20, but it would indicate a loss.
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Unrealized PNL
Unrealized PNL is the profit or loss that is presently maintained in open positions but is yet to be recognized through closing the position. The formula for calculating unrealized PL is:
Unrealized PL = Average entry price – Mark price
For instance, Blake has bought BTC contracts with an average entry price of just $1,900. Whereas, the mark price of BTC is currently $1,000. The unrealized P&L for Blake is simply the difference between the BTC entry price and the mark price.
Unrealized PnL = $1,900 – $1,000 = $900
How to Do PNL Calculation
To calculate PNL in cryptocurrency, a crypto trader has to estimate the difference between “the initial cost of buying a digital currency and the current market value of the exact digital coin”. Here are various methods you can use to calculate PNL in cryptocurrency:
1. First-in, first-out (FIFO) method
The FIFO technique needs the seller to make use of the price of the crypto asset from the initial stage it was first purchased. Here is a step-by-step process to estimate PNL with the use of the FIFO method:
a) To resolve the initial cost of the digital token, multiply the acquisition price per unit by the total number of units sold.
b) To define the current market value of the crypto asset disposed of, just multiply the current market price of the crypto per unit by the total number of units sold.
c) To find the PL, just deduct the original cost of the digital coin from the current market value.
Assume Person A first bought 1 BTC at $1,000 and then bought 1 BTC at $800 a few days later. One year later, he sold 1 BTC at $1,200. Since he first bought BTC at $1,000, this price will be deemed the initial cost. If he applies the FIFO technique, Person A can estimate his PNL as follows:
Person A’s initial cost = (1 BTC × $1,000) = $1,000
Current market value = (1 BTC × $1,200) = $1,200
PNL = $1,200 – $1,000 = $200 (profit)
2. Last-in, first-out (LIFO) method
This method needs the seller to make use of the most current purchase price of a crypto asset for the calculation. The other facets are precisely like the FIFO technique. Here is what the PNL looks like when using the LIFO technique assuming we are using the same example as above:
Person A’s initial cost = (1 BTC × $800) = $800
Current market value = (1 BTC × $1,200) = $1,200
PNL = $1,200 – $800 = $400 (profit)
3. Weighted average cost method
The weighted average cost technique needs crypto traders to calculate the average cost of all the units of a cryptocurrency in their portfolio to determine the initial cost. Follow the steps below to calculate PNL using this technique:
a) Identify the full cost of all units of the crypto token. Thereafter, multiply the purchase price per unit for every transaction by the total number of units of the crypto asset and add the numbers.
b) To get the weighted average cost per unit of the crypto token, just divide the full cost of all units by the total number of units.
c) Find out the present market value of the crypto token sold. Thereafter, multiply the current market price per unit of the token by the total number of units sold.
d) To estimate the PNL, just subtract the average cost per unit of the token from the current market value.
Assume Tom bought 1 ETH at $1,200 and a few days later, he bought 1 ETH at $2,000. He later sold off the 1 ETH at $2,400. Here is how to calculate the PNL with the use of the weighted average cost technique:
Total cost = (1 ETH × $1,200) + (1 ETH × $2,000) = $3,200
Weighted average cost = $3,200 / 2 ETH = $1,600
Current market value = (1 ETH × $2,400) = $2,400
PNL = $2,400 – $1,600 = $800 (profit)
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4. Profits/losses from opening and closing positions
Regularly studying open and closed crypto positions is a very efficient way to observe performance. An initial purchase a crypto trader makes in the crypto market is an open position, whereas selling the token is known as closing the position. If a trader purchases 10 BTC, it is called an open position. Whenever the trader sells off those BTC, the position gets closed.
For instance, if a crypto trader purchased 10 BTC for $60 and sold them for $90, then the trader’s PNL would be $30 ($90 – $60). Frequent analysis of crypto trades alongside the open and closed positions can help you trade in an organized and profitable manner.
5. Year-to-date (YTD) calculation
YTD is a mode of measuring the performance of crypto investments made from the beginning of the year up until the present date. Crypto investors who regularly buy and keep cryptocurrencies for a couple of years can easily know their unrealized profits with the YTD calculation.
All the trader needs to do is calculate the total value of the crypto portfolio at the start and end of one year and then compare these values. This may be a calendar year or fiscal year, it all depends on the individual’s preference or requirements.
Assume a person holds $1,200 worth of Bitcoin (BTC) on Jan. 1, 2022, and $2,000 worth of BTC on Jan. 1, 2023. In this situation, $800 is the unrealized profit. Essentially, unrealized profit indicates returns that are yet to be converted into money or other cash equivalents like term deposits.
6. Transaction-based calculation
A transaction-based calculation needs a crypto trader to calculate the PNL for each distinctive transaction. For example, if a person bought 1 BTC for $1,200 and sold it off for $1,500, the PNL amount for the transaction would be just $300 profit ($1,500 – $1,200). If the total number of transactions is not much and you want to calculate PNL for these transactions individually, then it is ideal to use a transaction-based calculation method.
What is PNL in Crypto and how to Calculate it? PNL, short for profit and loss in crypto, allows traders to evaluate their performance after a trade and make sound decisions accordingly quickly. In the crypto world, PNL is estimated on a far much shorter timeline, unlike in traditional finance. Usually, traders calculate it daily by using the same fundamental formula of subtracting the total cost of assets from the total income generated. Nevertheless, it can also be estimated hourly or even by the minute. It all depends on your needs as a crypto trader. This tool is essential for crypto traders who want to increase their chances of making substantial gains.
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