Trading with cryptocurrencies has become increasingly popular over the past few years. After all, investing in digital currencies like Bitcoin and Ethereum can be quite profitable. But how do you know if your investments will yield a return? Enter ROI – or Return on Investment.
So, what is ROI in the context of cryptocurrency? Simply put, it’s a measure of how much profit you make from your investments. It’s a ratio that compares your net gain to the cost of investment. For instance, if you invest $100 in a coin and sell it for $200, your ROI would be 100%. The higher your ROI, the more profitable your investments are.
As an investor, understanding and tracking your ROI can be key in making informed decisions about which coins to buy and sell. In this article, you’ll learn how to calculate your ROI, the limitations of ROI, and how to use this knowledge to maximize your profits.
What Is ROI in Cryptocurrency: At a Glance
ROI, or Return on Investment, is a commonly used metric when it comes to measuring the performance and efficacy of investments. It helps investors decide which cryptocurrencies to buy and sell in order to maximize their gains.
ROI is a ratio that compares your total net gain from an investment to the cost of the investment itself. It’s usually expressed as a percentage and is calculated by subtracting the cost of the investment from the total gain, dividing that result by the cost of the investment, and then multiplying that result by 100%
The formula for calculating ROI looks like this:
(Gain from Investment – Cost of Investment) / Cost of Investment x 100
This simple formula can help you determine whether or not it’s worth investing in a certain cryptocurrency. If the number you get from this equation is higher than 0%, it means that you’ve made a profit; if it’s lower than 0%, it means that you’ve lost money.
ROI in Cryptocurrency: Example
Let’s say that one year ago, you invested $2,000 in Bitcoin. This amount is your IVI (Initial Value Investment). Fast forward to today, the price of Bitcoin has gone up 25% since you bought it. That means that your current Investment Value (IV) is now $2,500.
Using the formula above, we can calculate our ROI:
(Gain from Investment – Cost of Investment) / Cost of Investment x 100
= ($2,500 – $2,000) / $2,000 x 100
= 0.25 x 100
In this example, your ROI is 25%. That means you’ve earned a 25% return on your initial investment of $2,000.
Note that the formula used above is for basic ROI calculation and assumes no additional costs, expenses, or fees.
While this base formula is convenient for getting an idea of how your investment is performing, it may not always be the most accurate or useful measure. This is because it is unrealistic to assume that you’ll be able to maintain your investment without additional expenses or fees.
For example, when you bought Bitcoin, you may have paid a brokerage fee. Likewise, when you sell it, you may incur taxes on your profits or other transaction fees.
Limitations of ROI: Why You Shouldn’t Rely on It Alone
While ROI can be a helpful tool for tracking your investments’ performance, it has its limitations. It does not factor in risk, time spent holding the asset, or any additional expenses associated with buying and selling the asset.
Let’s take a closer look at these potential issues with ROI.
ROI does not take into account the level of risk associated with a certain investment. High-return investments are typically higher-risk investments – and this is especially true in the world of cryptocurrencies.
Many new coins may post staggering high ROI numbers but come with incredibly high risks. One day, these coins could be the next Bitcoin; the next day, they could be worth nothing. Therefore, ROI should not be the only factor you consider when assessing an investment.
Expenses & Fees
The ROI formula used above does not take into account any additional expenses or fees associated with buying and selling the asset, such as brokerage fees or taxes on profits.
To get an accurate measure of how much money has been made from the investment, these costs need to be taken into account. This can be done by adjusting the formula to include these expenses, but realistically speaking, it is difficult to predict and account for all transaction fees that may be incurred.
Cryptocurrency transaction fees are extremely volatile and can come as a surprise to many investors. These fees can have a significant effect on your ROI, especially if your investment is a smaller one.
Finally, probably one of the biggest limitations of ROI is that it does not take the time factor into account.
The ROI of an asset that appreciates from $1000 to $1800 will be 80%, whether the growth happens over 1 year or 5 years. Of course, the former is more desirable, but ROI alone cannot tell you this.
A company can post an incredibly high ROI number, but if it achieved that return over a long period of time or with the significant risk involved, it might not be as attractive as one that was achieved faster and with less risk.
To overcome this limitation, investors should consider the annualized ROI measure.
What Is Annualized ROI: An Overview
Annualized ROI is a measure of return on an investment that takes into account the tenure of the investment. It expresses the standardized annual rate of return, taking into account all cash flows over the entire holding period.
In short, annualized ROI shows the percentage rate of return on a yearly basis, accounting for every dollar invested at any point in time during the holding period.
The formula for calculating annualized ROI is as follows:
[(1 + ROI)1/n – 1] x 100
Where n indicates the number of years taken to achieve that return.
For example, an investment that appreciates from $1000 to $1800 over a period of 5 years would have an annualized ROI of 14.4%, while the same investment with the same returns over 1 year would have an annualized ROI of 80%.
Tips to Make a Positive ROI When Investing in Cryptocurrency
Now that we understand what ROI is and how to measure it, let’s look at some tips for making a positive ROI when investing in cryptocurrencies.
Choose Your Platform Carefully
The platform you choose when investing in cryptocurrency is extremely important for maximizing your return on investment.
Platforms like Binance offer low transaction fees, making it easier and more cost-effective to move money in and out of the market. They also offer features such as margin trading and stop-loss orders, making it easier to manage risk when investing.
It’s also a good idea to look for platforms that offer advanced analytic tools that can help inform your trading decisions. For example, some platforms have built-in charting tools that can be used to track price movements, while others have features that can help you identify potential buying and selling opportunities.
Diversify Your Portfolio
Cryptocurrency markets are notoriously volatile, making it difficult to predict their movements from one moment to the next.
Diversifying your portfolio is an important tip for making a positive ROI. By spreading your funds across a range of different cryptocurrencies, you can minimize the risk associated with any particular asset and maximize your potential ROI.
The idea behind portfolio diversification is to manage risk by investing small amounts into a bigger pool. It’s important not to put all your eggs in one basket – if you invest in just one or two cryptocurrencies, you could be taking on a higher amount of risk than necessary, as you have no way of knowing how those currencies will perform in the future.
For example, if you invest $1000 in Bitcoin and it goes up by 10%, you’ve made a net return of $100. If, however, you invest the same amount in five different cryptocurrencies, and each of those currencies goes up by just 5%, then your net return would be $250 – more than double what it was when investing in a single asset.
Finally, it’s important to remember that making a profit from cryptocurrency investments takes time. Unlike stocks or bonds, which can produce returns in a short period of time, cryptocurrencies are more of a long-term investment.
It’s important to be patient with your investments and not get too attached to any particular asset. Markets can move quickly and drastically, so it’s important to be able to recognize when it’s time to cut your losses and move on.
Return on investment is an important concept to understand when investing in cryptocurrency, as it can help you make informed decisions and maximize your potential profits.
Now that you understand the concept of ROI and how to measure it, make sure to follow some of our tips for improving your chances of making a positive return on your investments. With some patience and careful planning, you can increase your chances of success when investing in cryptocurrency!