Key takeaways
- Return on Investment (ROI) compares the current value of an asset to its original value to determine its performance.
- Calculating ROI for crypto assets involves subtracting the initial value from the current value, dividing it by the initial value, and multiplying by 100.
- Positive ROI indicates a profit, while negative ROI suggests a loss.
- ROI is a valuable metric for evaluating the performance of crypto assets, but it has limitations.
- Alternative metrics to ROI like Internal Rate of Return (IRR) or Risk-Adjusted Return consider additional factors like time, cash flow, and risk, providing a more comprehensive assessment of investment performance.
What Is ROI in crypto
If you're trading cryptocurrency, it's crucial to regularly assess the performance of assets compared to the wider market. A basic, tried-and-trusted tool for this is Return on Investment (ROI), a widely used financial metric that compares the current value of an asset to its original value.
ROI works for real estate and traditional finance (TradFi) just as well as for crypto and decentralised finance (DeFi). It enables users to assess whether their crypto assets are appreciating or depreciating in value (i.e., are they bringing returns?). Here, we delve into how ROI is calculated, how useful it is, as well as alternative ways to measure the success of crypto assets.
How to calculate ROI for cryptocurrency
Calculating ROI for cryptocurrency is straightforward:
Return on Investment Percentage = [(Current value of investment – Initial cost of investment) / Initial cost of investment] x 100
For example
Suppose you bought one Bitcoin for US$10,000, and its current value is US$40,000.
To calculate its ROI, apply the formula from above:
ROI = [(40,000 – 10,000) / 10,000] x 100
We arrive at an ROI of 300%, a significant positive gain and return on investment.
Now, suppose instead you bought Bitcoin for US$60,000, and its current value is US$40,000.
Applying the ROI formula again:
ROI = [(40,000 – 60,000) / 60,000] x 100
We arrive at an ROI of -33%. This indicates a negative return on investment (i.e., loss).
ROI calculators
If you aren't a fan of calculations, there's a myriad of ROI calculators handy on the internet to simplify the process.
Why calculate ROI for crypto assets
Calculating ROI for your cryptocurrency has several benefits:
- Performance evaluation: ROI helps to provide an assessment of the profitability of crypto assets. Comparing different cryptocurrencies can help to identify which ones are currently successful in order to make informed decisions about how best to proceed when purchasing crypto assets.
- Portfolio optimisation: Understanding the ROI of assets helps optimise your crypto portfolio. Many portfolio optimisation methods need expected returns (e.g., ROIs) as inputs to calculate ideal weights (i.e., how much to hold) of each asset in a portfolio.
- Cash flow assessment: Many traders use a positive cash flow strategy to expand their portfolio. Calculating ROI provides insights into the cash flow generated by your assets, enabling you to make informed decisions regarding how much capital could potentially be put to work in new acquisitions.
Alternatives for crypto ROI
ROI is a valuable, albeit basic, base metric. In other words, for a more complex analysis of your trading portfolio, you'll need to employ more tools. Below are alternative methods to consider for assessing the success of crypto assets:
Annualised ROI
The basic ROI calculation does not consider how long an investment was held to achieve the return. It is easy to see why it matters if an asset took 1 or 10 years before achieving an ROI of 100%. This also allows you to compare an asset that made a 50% ROI in two years with another one that made 50% over 10 years.
Here's the adjusted formula:
Annualised ROI = [(1 + ROI)1/n – 1] x 100
Where n = number of years asset is held
In our example, the asset with a 50% ROI in two years has a 22% annual ROI, as calculated by:
[(1 + 0.5)1/2 – 1] x 100 = 22%
Whereas if it took 10 years, then the annual ROI would be 4%, as calculated by:
[(1 + 0.5)1/10 – 1] x 100 = 4%
Internal Rate of Return (IRR)
As already mentioned, basic ROI does not consider how long a cryptocurrency was held to achieve the return. IRR is a return metric that considers the time value of money (i.e., the concept that a dollar today is worth more than a dollar anytime in the future since the dollar can earn interest, which compounds over time). In other words, it gives an annual growth rate.
As time goes by, the IRR of an asset decreases compared to the ROI, which remains constant. IRR also takes into account cash inflows and outflows of a portfolio. IRR calculations are fairly complex, so it's best to use an IRR calculator to compute them.
Comparative analysis
Comparing the performance of crypto assets to popular indices or industry benchmarks provides valuable insights. Users can compare the ROI of crypto assets with the performance of other cryptocurrencies or other asset classes, like stocks, funds, or exchange-traded funds (ETFs).
Crypto.com's monthly Alpha Navigator pitches BTC performance against other asset classes like gold, showing if Bitcoin outperformed or underperformed compared to popular assets. This type of analysis is also known as relative performance.
Risk-adjusted return
Note that ROI does not account for risk. If one asset achieves a higher ROI but is a much higher risk, while another produces a lower ROI but is a lower risk — which one would you consider the better choice? Risk-adjusted metrics, such as the Sharpe ratio or the Sortino ratio, assess the risk-return trade-off of crypto assets and can help selecting cryptocurrencies that match your appetite for risk and investment philosophy.
Calculating ROI for crypto assets is essential to evaluate profitability and optimise investment portfolios. By understanding the formula and its application, cryptocurrency holders can assess the success of their assets and make informed decisions based on data-driven insights.
However, it's important to recognise the limitations of ROI and consider alternative metrics like IRR and risk-adjusted measures for a more comprehensive evaluation of crypto assets. Staying informed and regularly assessing the performance of crypto is key to long-term success in the dynamic world of cryptocurrencies.