The cryptocurrency market is becoming popular and with this popularity, comes the worries of being able to calculate the profit made in this trade. While some people just do a simple estimate to check their profit, it is advisable to know exactly how to calculate your performance and profit.
Getting a precise calculation of cryptocurrency profits requires a good understanding of how to calculate returns in different scenarios. This calculation involves a process of factoring withdrawals, deposits, and other conditions to get the right value of your portfolio. The process may look a bit complex, but, can be mastered easily.
Basic Formula For The Return Rate
Return Rate (RoR)
The rate of return is used to calculate cryptocurrency profit when a portfolio is steady, that is, funds have not been added or removed from the portfolio. The simple formula for the rate of return is :
RoR = [(Vc – Vi) / Vi] × 100
Vc is your portfolio’s current value.
Vi is your portfolio’s initial value. This means that you have to use the value of your portfolio 24 hours ago to calculate its 24-hour performance.
Then, multiply by 100 to convert to a percentage.
This calculation gives you the rate of return for your portfolio over a chosen period between the current and initial value of your portfolio.
Challenge With Using RoR
The issues involved with using the Rate of Return include:
- RoR calculations are only used for times when there were no deposits or withdrawals from your portfolio.
- If deposits or withdrawals have been made on the portfolio, these actions will be counted as performance and can’t be used.
Return Rate That is Weighted With Time (TWR)
This involves calculating a portfolio’s performance over a period, using a more complex formula. With the TWR, deposits, and withdrawals can be factored in and then, accurate calculation of the rate of return over a specified time can be done.
Additional funds that are deposited into a portfolio should not be counted as profit when managing a portfolio on an exchange as these funds came from another wallet. So, performance calculations should indicate the performance that came through your strategy and the ones that are deposits or withdrawals.
The result gives a system that breaks the calculation of performance into periods. Each of the periods will be calculated separately and combined to make the conclusive time-weighted rate of return.
The TWR formula defines two periods: “A” and “B”. Period ” A” comprises all the time till the moment before the deposit, while period “B” comprises the deposit and the time left to calculate the performance. Here is the formula below:
Return Over Period A = [(Vaf – Vai) / Vai]
Vaf is the final value of the segment “A“.
Vai is the initial value of the segment “A“.
Return Over Period B = [(Vbf – (Vaf + DW)) / (Vaf + DW)]
Vbf is the final value of the “B” segment.
Vaf is the final value of the “A” segment.
DW is the deposit or withdrawal value.
Time-weighted return = ((1+ROPA) × (1+(ROPB)) – 1) × 100
ROPA is the rate of return over period “A“.
ROPB is the rate of return over the period “B“.
Then, multiply by 100 to convert to a percentage.
If an investor in crypto sends $1,000 BTC to an exchange on a Sunday. After the deposit, on the first Wednesday, his portfolio worths $1,128. If he adds another $100 to his portfolio that Wednesday, he has a new total of $1,228.
The portfolio losses value on Saturday and the final balance at the week’s end to $1,199. To get the value of the portfolio over a week, use the simple rate of return formula:
Return = [($1,128 – $1,000) / $1,000] × 100 = 12.8%
To calculate the portfolio performance from the time of second deposit on Wednesday to Saturday which is the second period, use the TWR formula:
Return = ($1,199 – ($1,128 + $100)) / ($1,128 + $100) × 100 = -2.4%
Challenges of TWR
The challenge with applying the TWR formula is that in the instances provided, situations where, where funds were withdrawn or deposited, considered because they are straight forward events since the time they take place are known and affect the portfolio’s value immediately.
All situations in cryptocurrency are not as easy as knowing when funds were withdrawn or deposited which makes some scenarios not to have an answer as to how the performance should be calculated.
Factors That Affect The Prices of Cryptocurrency
Some of the factors that affect the prices of cryptocurrency include:
- Cryptocurrency Demand and Supply: the supply rate of coins can be low compared to the level of demand. It remains low till this cryptocurrency grows to a targeted million. The time it takes to grow assures investors that the coins price will keep growing too.
- Changes in Regulation: the value of cryptocurrency is greatly influenced by the possibilities of future regulation because its regulation is not yet determined. For instance, a government could restrict its citizens from holding cryptocurrencies just like gold ownership was prohibited in the 1930s in the United States. Such case a could likely make cryptocurrency move offshore, but its value would however be badly undermined.
- CrytoCryptocurrencyications: the use case of cryptocurrencies is what determines there value. A rare metal mined by a miner has the potential to rapidly appreciate in value if it is used but remains worthless if it is not used. In the same way, Bitcoin has value because it can be used for trade; other types of cryptocurrencies can refine and become better than the Bitcoin or evolve into a more valued use. The increase in cryptocurrency use causes an increase in its value and demand.
- Changes in Technology: the prices of cryptocurrency is affected by changes in technology. The price of Bitcoin reduced in 2017 when there was a controversy about changing the technology to improve times of transaction, but its price greatly increased when the technology change was completed. The price went from $2700 to about $4000 in a little over two weeks.
As the interest in cryptocurrency is increasing, so is the level of investment increasing too. But what seems not to increase is the knowledge of how to calculate the profits or returns that come with cryptocurrency. Following the methods above will help you calculate the performance of your portfolio to know when you are making profits in cryptocurrency.