Trading and investing in cryptocurrencies can be challenging at times without proper analysis and smart decision-making. It is imperative to understand how your existing investment performs before making further investment-related decisions. Return on Investment (ROI) is a great tool to start. However, there are a few things you need to know when it comes to calculating ROI for crypto.
What Is Return on Investment (ROI)?
Return on Investment is one of the measures to evaluate the performance of an asset in the market. As the market is all about buying things when the price is low and selling them during price gain, ROI tells us if a market strategy is working or not. If the ROI of a project isn’t good enough, it indicates the need for changing the investment strategy.
Although ROI does not consider as many factors as other market analysis tools do, it clarifies how your asset performs concerning its past performances. For instance, when Technical Analysis of an asset will explore how it has endured different market changes over a period. On the other hand, ROI only pays attention to the tangible profit the asset has produced over time.
Of course, you cannot use ROI as the sole guide to planning all your investment strategies. Over the period, you need to consider aspects like market risk and volatility. Nevertheless, if you want to know if the asset has been performing well or not, you can count on ROI. The best part is that you can use ROI to analyze the performance of traditional assets and crypto-assets.
First, we will see how you can calculate the ROI of a general and more conventional asset.
How to Calculate the ROI of an Investment?
The ROI calculation formula should not intimidate you by any chance. It is so simple, and anyone with a basic understanding of mathematics can do that.
A = The current value of the investment.
B = The original cost of the investment.
ROI = (A-B)/B
ROI is equal to (Current value – Original cost)/Original cost.
Let’s take a more real-life-friendly example to understand what ROI stands for.
Let’s say you purchased a real estate property by paying $100,000. After some time, when you think it is the right time, you sold the property for $150,000.
Here is the thing, though. To keep the real estate property in the right way, you may have spent some extra money. Suppose you have paid around $20,000 for regular maintenance and repairs of the property. The point is that you have to reduce this amount from the current value of the asset.
So, the calculation would be like this:
ROI = (130,000 – 100,000)/100,000
= 30000/100,000 = 0.3
You see, the current value has been adjusted after considering the amount you have spent on the asset.
After that, the ROI of the investment is 0.3. If we talk in terms of percentages, it means you received a 30% return on this investment. You can also find the profit from the investment by multiplying ROI by the original cost of the investment.
In this case, that figure will be 0.3 x 100,000, which is equal to $30,000. As you can see, this figure is inclusive of the extra money you have spent on the asset so far.
How to calculate the ROI for crypto?
In the world of crypto assets, you can calculate the Return on Investment by reducing the original price of the crypto asset from the asset’s selling price. Then, you have to divide the result by the actual cost of the investment.
For example, if you buy some crypto for $5000 and sell it for $20000, the ROI would be 3.0. Meaning you received three times (300%) your original investment. However, you have to consider a few additional aspects like the transaction fees involved and the overall liquidity of the asset.
Considering that dynamic transaction fees bind crypto assets, you should also consider how much you pay for the buying/selling process. In other words, a simple ROI figure would not provide you a complete picture of how the crypto asset performed. If you need such comprehensive data, you need to do more research.
Why is the return on investment is not enough?
There are a few factors that ROI willfully ignores. From an overall market perspective, these factors may be necessary. Some of them are:
- ROI calculation does not consider time as a crucial factor. ROI, in general, does not specify the time it applies to. That is why experts and entities come with a concept called annualized ROI, which refers to the progress made within a year.
- While ROI tells us the asset’s performance, it fails to explain the asset’s environment. We cannot know about potential market risks or changes in liquidity. That is why you need more than just ROI to devise a trading strategy.
- The trader may also need additional calculations to understand the precise value of assets, especially when dealing with inflation. Since ROI calculation compares the current price and the original cost, the numbers may not precisely sync with the result.
Despite these shortcomings, you can consider ROI as one of the first steps to understand whether the asset in question is worth your effort. However, you have to pay more attention to a few more aspects like liquidity and volatility in crypto assets.