How to make sense of your crypto investments: gains and ROI explained
Lot’s of people have been getting into crypto the past few years. Many of which have very little investing experience. Some think this is a bad idea. I am not one of those people. But that’s a whole different article.
In this article I will explain how to make sense of your investments. How to determine much you have (potentially made) or lost. I will also cover some fancy financial terms; both what they mean in the general sense and how they apply to crypto investments.
Let’s start by assuming you have been listening to your favorite crypto Youtuber who’s been telling you you should be Dollar Cost Averaging (DCA) when buying your crypto investments. If your favorite Youtuber has been telling you to take all your savings and buy a bunch of Dog coins…. well, it’s time to fire said Youtuber and find yourself a new one (don’t worry, there’s plenty of ‘em).
So here you are, doing the DCA thing. Taking a $100 or so every month to buy some legit digital assets. Well on your way to soon join the ranks of crypto millionaires! Small problem though: since you’re buying monthly at different prices, keeping track of how well your portfolio is doing is becoming trickier each month. And your favorite exchange showing you the value of all of your assets over time isn’t exactly helpful… And things become even more complex when you start selling assets as well as buying. What we want to know, what we really want to know, is how much we have, potentially gained (or lost) by buying assets every month.
Unrealized gains, realized gains, ROI and ARR
Before we can make sense of all of this, we will have to run through a couple of fancy financial terms.
- Unrealized gains (or losses)
Let’s assume you have purchased 2 ETH, at $2,000 each (so you spend a total of $4,000). A month later, the price of ETH has gone up and is now $2,500 per ETH. Yeah, big money! Assuming you still have your 2 ETH, you know have a theoretical gain of $1,000 (since your 2 ETH are now worth $5,000, which is $1,000 more than you paid for it a month prior). This $1,000 is what’s called “unrealized gains”. The “unrealized” part refers to the fact that you have not realized those gains, since you have not yet sold your ETH. As long as you refrain from selling any of your assets, all of your gains remain unrealized. Obviously, despite of what your Youtube investment guru is telling you, crypto can also go down in price. Let’s assume your ETH as depreciated and is now worth $1,500 per ETH. You’re now looking at an unrealized loss (essentially a negative unrealized gain) of $1,000. - Realized gains (or losses)
Realized gains, or losses, come into play when you are selling either all or part of your crypto. At the moment you decide to sell some of your crypto, you turn an unrealized gain, or loss, into a realized one. Sticking with the example from the previous paragraph, let’s assume your ETH has increased to $2,500 per ETH. You have decided to sell 1 ETH for $2,500. Since you acquired the 1 ETH for $2,000 and sold it for $2,500, the gains realized by this transaction is $500. Hoorah! Since you’re holding on to the other 1 ETH, at this point you have realized gains of $500, as well as unrealized gains of $500 (since you still own that 1 ETH). - ROI
Return On Investment, ROI, is a performance measure used to evaluate the performance of an investment. It’s a ratio, typically expressed as a percentage, representing the earnings of an investment compared to the cost of the investment. The formula is rather simple: (current value — cost) / cost x 100. Simple no? Let’s look at our ETH example again and assume we sell 2 ETH after the price has increase to $2,500 per ETH. Our gains in this case, are $1,000. Our cost was $4,000 (what we paid for the ETH when we purchased it, for sake of simplicity we’ll ignore transaction costs for now). Apply the ROI formula: (5000–4000) / 4000 x 100 = 25%. In this example, you’re looking at an ROI of 25%, not too bad! - ARR
Annualized Rate of Return is kinda like ROI, but slightly different. You see, ROI does not take time into account. Sticking with the previous example, the ETH price increase from $2,000 to $2,500 could have happened over 6 months, 1 year or 5 years. This obviously makes quite a difference. An ROI of 25% over 6 months is definitely not the same as that same ROI over 1 year or 5 years. This is where the ARR metric comes in handy. ARR allows us to standardize the ROI per year, using a certain formula. Going over the exact formula in detail is beyond the scope of this article, but for those interested, Investopedia does a good job explaining it. Using the formula from Investopedia, and assuming an ROI of 25% over 5 years, we get an ARR of 4.6%. This nicely illustrate that the time over which an ROI is calculated is pretty important.
What happens when we start selling crypto?
Things remain fairly simple as long as we are only buying and hold off selling or trading any assets. However, once you start selling assets, it gets slightly more complicated.
Consider the following example. You have started Dollar Cost Averaging and made the following purchases:
- 1 ETH, for $2,000 (@1ETH = $2,000)
- 0.8 ETH, $2,000 (@1ETH = $2,500)
- 0.6 ETH, $2,000 (@1ETH = $3,333)
- 0.5 ETH, $2,000 (@1ETH = $4,000,33)
- 1.2 ETH, $2,000 (@1ETH = $1,666.66)
- 1.3 ETH, $2,000 (@1ETH = $1,538.46)
So far, so good. You now have a total of 5.4ETH for which you paid, in total, $12,000 (again, for the sake of simplicity we’re ignoring transaction costs for now). Let’s now assume that today, the ETH price is $3,500. This means that if you were to sell all of your 5.4 ETH today, you’d pocket $18,900. This puts our unrealized gains at $18,900 — $12,000 = $6,900.
Let’s now assume that you’re feeling pretty good about these agains and you’d like to sell some ETH. You decided to sell 1.5ETH, at today’s price of $3,500, for $5,250. Where does this leave your portfolio in terms of unrealized, and now realized, gains? Obviously you no longer have $6,900 in unrealized gains, since that calculation was based on you owning 5.4ETH, which you no longer do.
This brings up an interesting question: which ETH did you actually end up selling? Of course we all know that 1ETH is no different from the next 1ETH. However, from an accounting (and tax) perspective, there’s a definite difference. Since you have bought ETH at different prices, deciding which ETH you sell, or respectively, keep in your portfolio becomes relevant at this point. There are several generally accepted methods for determining which ETH gets sold. Covering each of these methods is beyond the scope of this article, but we will cover two regular used methods:
- First In First Out (FIFO)
Pretty much self explanatory this one. The ETH that was “first in”, will go “first out”. In other words, the ETH that is sitting in your portfolio the longest gets sold first. - Lot based
With this approach, you are free to determine which ETH gets sold first. When you acquire your ETH, it is assigned a “lot ID”, which is a unique identifier to identify that ETH. Please note that this ID does not apply to a single ETH; rather it applies to all ETH that was acquired in a single transaction at a certain price. In our case above, you’d have six ID’s, since you purchased ETH six times at different prices.
Working out gains after selling ETH
Now let’s see how the above described FIFO method works out for our example. Remember, you have sold 1.5 ETH (for $3,500 per ETH). So there’s 1.5 ETH that left your portfolio that we need to account for.
Your first purchase transaction was 1ETH. Using this 1ETH, you have another 0.5 ETH to account for (1.5ETH — 1ETH = 0.5ETH). Your second purchase transaction was 0.8ETH. However, you only need 0.5 from that 0.8 ETH, leaving 0.3 ETH from that second transaction to spend at some point in the future. Hoorah! Now that you know which ETH you’re selling, you also know how much you paid for this ETH: $2,000 for 1 ETH and $1,250 for the remaining 0.5ETH (1ETH from the first transaction and 0.5ETH from the second transaction). Some quick math tells us you paid $3,250 ($2,000 + $1,250) for the 1.5ETH you have sold. In other words, the cost base for these 1.5ETH is $3,250. Knowing the cost base, we can now easily determine the realized gains for this transaction: current value — costs = $5,250 (1.5ETH * $3,500) — $3,250 = $2,000. And there we have it; realized gains for said transaction.
We can now take a similar approach to calculate the unrealized gains for the remaining 3.9ETH in our portfolio. We first need to determine the cost base:
- 0 ETH, for $2,000 (@1ETH = $2,000) -> $0
- 0.3 ETH, $2,000 (@1ETH = $2,500) -> $750
- 0.6 ETH, $2,000 (@1ETH = $3,333.33) -> $3,333.33
- 0.5 ETH, $2,000 (@1ETH = $4,000) -> $4,000
- 1.2 ETH, $2,000 (@1ETH = $1,666.66) -> $1,666.66
- 1.3 ETH, $2,000 (@1ETH = $1,538.46) -> $1,538.46
All the ETH from the first transaction was spent. From the second transaction, 0.3ETH remains. Adding them all up brings to a total cost base of $11,288.45 for the remaining 3.9ETH. With today’s price at $3,500 per ETH, the total unrealized gains can be calculated as such: $13,650 (3.9ETH*$3,500) — $11,288.45 = $2,361.55.
Applying the “lot based” approach to accounting for ETH sold is generally the same principle, except that with the lot based approach you choose which ETH is sold rather than working through acquired ETH in chronological order. It’s important to remember though, which ever method is used, all the purchased ETH can only be sold once. Another important thing to remember is that you should not switch methods once you have started applying one: you can not use the FIFO method for the first sell transaction and switch to a different method.
Which approach to choose depends on the purpose. Unless you’re doing accounting of your assets for a specific purpose (taxes or other), sticking with FIFO seems to be a good approach.
Unfortunately, I have found very few apps or SaaS application that do represent this data well for crypto portfolios. Hence, you’ll find that you’ll typically be doing these calculations in a good old fashioned spreadsheet.
To wrap this up, let’s bring it back around and apply the above to calculate the ROI after selling that 1.5ETH for $3,500. As we calculated, the cost base for that 1.5ETH was $3,250 and the current value is $5,250. Using the ROI formula: ($5,250 — $3,250) / $3,250 * 100 = 61.54%. Now, that ain’t too shabby of a return eh?
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