Profit and Loss (PnL) is a crucial concept in both traditional finance and the cryptocurrency world. However, understanding PnL in the cryptocurrency market requires grasping terms like mark-to-market (MTM), realized PnL, and unrealized PnL. These terms help traders gain a deeper understanding of the value fluctuations of the cryptocurrencies they hold.
Without a clear process to assess profit or loss, cryptocurrency trading can be overwhelming, leading traders to struggle with their strategies. PnL reflects the changes in a trader’s positions over a specific period, providing insights into their financial performance.
To better understand PnL in cryptocurrency trading, let’s delve into the basics.
PnL in the crypto market refers to the calculation of profits or losses made on cryptocurrency investments or trading positions. It serves as a metric to evaluate a trader or investor’s financial performance in the crypto market.
Here are some key terms to understand in PnL terminology:
1. Mark-to-Market (MTM):
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, such as Bitcoin (BTC), fluctuates based on the current market price.
The general formula for calculating PnL is:
PnL = (Current MTM Price – Previous MTM Price) * Quantity
For example, if the MTM price for Ether (ETH) today is $1,970, and yesterday it 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.
2. Future Value:
Future value represents the value of a digital coin at a specific point in the future. For instance, if a trader stakes Tron (TRX) worth $1,000 with a 4% yearly reward, they would receive $1,040 after one year. The present value at the time of staking would be $1,000, while the future value would be $1,040.
Alternatively, traders can also determine how much they need to stake to achieve a specific future value. By knowing the present and future values, traders can calculate the discount factor using the formula:
Discount Factor = Future Value / Present Value
3. Realized PnL:
Realized PnL is calculated after traders close their positions by selling the cryptocurrencies they hold. It only takes into account the executed price of the orders and is not directly related to the mark price.
The formula for calculating realized PnL is:
Realized PnL = (Exit Price – Entry Price) * Quantity
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.
4. 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. It can be calculated using the formula:
Unrealized PnL = (Average Entry Price – Mark Price) * Quantity
For example, if a trader 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.
To calculate PnL in cryptocurrency, traders need to determine the difference between the initial cost of acquiring a digital coin and its current market value. Different methods can be used, such as the First-in, First-out (FIFO) method, Last-in, First-out (LIFO) method, or Weighted Average Cost method.
Analyzing open and closed positions regularly helps monitor performance and trade in an organized manner. The year-to-date (YTD) calculation measures the performance of investments made in cryptocurrency from the start of the year to the current date.
Calculating PnL for perpetual contracts, which are futures contracts with no fixed settlement time, requires calculating both realized and unrealized PnL and adding them together.
Understanding PnL in cryptocurrency trading is essential for assessing the efficiency of trading strategies and making informed decisions. There are tools like spreadsheets and automated trading bots available to help traders analyze their performances and identify profitable trading opportunities.