Business

How Do You Calculate Profit and Loss in Cryptocurrency?

Cryptocurrency

The cryptocurrency market is currently worth over $2.2 trillion and is as volatile as ever due to a growing number of new crypto coins and rising crypto adoption. With drastic changes in prices and more coins to invest in, there has never been a better time to invest in the crypto market. 

While more coins mean higher chances of making good returns, it also calls for a deeper understanding of how to track and calculate your crypto profits and losses. Here are benefits and techniques commonly used to calculate crypto gains.

Why You Need to Calculate Profit and Loss in Crypto

Similar to traditional financial markets, your success in trading crypto assets relies on how well you track your investment portfolio. It involves calculating your crypto gains/losses. This helps you to:

  • Evaluate your trading strategies
  • Easily manage your portfolio
  • Reevaluate your investment decisions
  • Keep accounting records that come in handy when filing crypto taxes

Ways to Calculate Crypto Gains

The crypto market is quite young. Most crypto exchanges and brokers lack a full suite of professional tools that track profit and loss as in the case with equity markets. However, we are now seeing an emergence of third-party services offering crypto trading bots and portfolio trackers that help calculate the % increase or decrease in one’s investments. Most of these tools calculate crypto profits and losses using the Cost Basis Method. 

Let’s have a look at how to use this method;

Calculating using the Cost Basis

The cost basis concept lets you calculate a crypto’s asset value based on the purchase price and the accompanying fees and transaction costs. The concept can be applied in two main ways as you track your crypto gains.

  1. Based on Fiat Currency

This involves calculating your crypto cost basis using local fiat currency. You can base the crypto cost on the USD, GBP, EUR, or JPY among other common fiat currencies.

Take the USD for example. If 1 BTC was worth $30,000 in 2020 and you bought BTC worth $10,000, you’d get 0.33 BTC. 

Say, you sold the 0.33 BTC a year later when the value of BTC rose by 100%  to $60,000. The value of your 0.33 BTC will also increase by 100% hence will be worth $20,000. It means a $10,000 profit on your investment. In case you are required to file tax reports, you’d owe taxes based on the $10,000 gains excluding the fees and other transaction costs.

However, while measuring your crypto gains/losses using a fiat asset seems straightforward, the method has various shortfalls. For instance, most crypto exchanges still don’t support fiat currencies; hence you can’t use them as a base currency on the platforms. 

  1. Based on Bitcoin Price

Most traders opt to calculate their portfolio gains using Bitcoin since it is a common crypto entry point. In most cases, traders will acquire BTC using a fiat currency before converting it to other altcoins. 

This is easily done on exchange platforms that offer a cryptocurrency calculator. You simply input the number of BTC you want to send and the calculator shows the exact amount you receive on your altcoin wallet.

This cost basis approach calculates the opportunity cost of holding and not using BTC to purchase other crypto assets. Opportunity cost is the value of the option you didn’t choose. 

Imagine that you bought 1 BTC at $50,000 and then decided to use the Bitcoin as your base currency (BTC/DOGE) to purchase 100,000 Dogecoins each valued at $0.50. If the value of DOGE doubled to $1.00, but the value of BTC tripled to $150,000, the opportunity cost would be $50,000. This is the difference between the new value of BTC($150,000) and that of your 100,000 Dogecoins now valued at $100,000. While you still gained $50,000 on the DOGE, you lost out on making an extra $50,000 if you had held on to your BTC.

The only problem with using BTC as a base currency lies in the constant exchange rate fluctuations between trading pairs.

Cost Basis Tools

Manual cost basis calculations can be difficult when you have too many transactions. As a result, new crypto tracking tools are leveraging various dynamic models that combine the best-of-the-cost basis method while avoiding its pitfalls. 

One common model used when dealing with multiple transactions involves calculating the average cost of each coin before calculating the true gain or loss of each currency in a fiat currency. 

Other cost basis calculation tools use the First In First Out (FIFO) and Last In First Out(LIFO) methods to calculate multiple crypto transactions for traders. With FIFO, the tools calculate cost basis starting with the first coin you bought. In LIFO, your most recent coin transaction is calculated first.  These are the recommended methods for crypto tax calculation by the Internal Revenue Service (IRS).

Conclusion

Calculating your crypto gains manually can be difficult. Thankfully today, you can easily get timely updates on your crypto profits or losses through crypto tracking tools such as Coin Market Manager, Delta, Lunch Money, and CoinStats among others. 

However, we are yet to see exchange platforms and brokerages offering professional trading tools that allow users to calculate crypto gains seamlessly as they would in equity markets. Understanding the cost basis approach should help you calculate your portfolio’s gains and losses – albeit difficult and time-consuming – as you look for a tracking tool that suits you best.

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