Realized Profit and Loss (P&L) is a fundamental concept in trading, referring to the actual gains or losses that occur when a position is closed. In the context of cryptocurrency, it specifically denotes the profit or loss generated from a spot or derivatives trade before settlement or delivery.
Understanding how realized P&L works is essential for every trader, as it directly impacts your portfolio's performance and tax liabilities.
Key Concepts in Cryptocurrency Trading
To fully grasp realized P&L, one must be familiar with the ecosystem in which it operates. Here are some core components.
Spot Trading
Often called coin-to-coin trading, this is the direct exchange of one digital asset for another. Platforms facilitate these trades in various markets, such as trading pairs with USDT, USD₮, BTC, or ETH. It is the most straightforward form of crypto trading.
The Role of Mark Price and Index Price
In derivatives trading, calculating unrealized and ultimately realized P&L relies on specific pricing mechanisms.
- Index Price: The reference price, typically derived from a weighted average of spot prices across major exchanges.
- Mark Price: This is the price used to calculate unrealized P&L and avoid unnecessary liquidations during high volatility. It is not the last traded price but a more stable value calculated as: Mark Price = Index Price + Moving Average of Basis.
- Order Price: The price at which a user places a buy or sell limit order.
The Mark Price mechanism smooths out short-term contract price fluctuations, ensuring a fairer representation of a position's value before it is closed and its P&L is realized.
Derivatives: Futures and Options
Realized P&L is also crucial in more complex financial instruments.
- Futures Contracts: Agreements to buy or sell an asset at a predetermined future date and price. Realized P&L is locked in when the contract is closed before expiry or upon settlement.
- Option Contracts: These give the buyer the right, but not the obligation, to buy (call option) or sell (put option) an asset at a set price before a certain date. The P&L from buying or selling these contracts becomes realized when the position is closed or the option is exercised.
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How is Realized P&L Calculated?
The basic formula for calculating realized P&L is straightforward:
Realized P&L = Exit Price - Entry Price - Fees
For a long position, you subtract the entry price from the exit price. For a short position, you reverse it: Entry Price - Exit Price. Trading fees must always be deducted to get your true net gain or loss.
An Example Calculation
Imagine you buy 1 Bitcoin at an entry price of $50,000. You later sell it at an exit price of $55,000. Assuming a 0.1% fee on both trades:
- Entry Fee: $50,000 * 0.1% = $50
- Exit Fee: $55,000 * 0.1% = $55
- Gross Profit: $55,000 - $50,000 = $5,000
- Total Fees: $50 + $55 = $105
- Net Realized P&L: $5,000 - $105 = $4,895
This $4,895 is your realized profit.
Realized P&L vs. Unrealized P&L
It's critical to distinguish between these two states of profit and loss.
- Unrealized P&L: This is the current profit or loss on an open position that has not yet been closed. It fluctuates with the market price. It is "paper" gains or losses.
- Realized P&L: This is the actual profit or loss that is locked in only after a position has been closed. This is the money that has actually been added to or subtracted from your account balance.
A trader's portfolio will show both figures, but only realized P&L affects your available capital for new trades.
The Importance of Tracking Realized P&L
Meticulously tracking your realized P&L is not just good practice—it's essential for several reasons.
- Performance Analysis: It allows you to accurately assess the effectiveness of your trading strategies over time.
- Risk Management: Understanding your historical gains and losses helps you refine position sizing and manage risk better.
- Tax Compliance: In most jurisdictions, tax obligations are triggered upon the realization of a gain or loss. Every time you close a position, it is a taxable event. Accurate records are necessary for reporting capital gains or losses.
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Frequently Asked Questions
What is the difference between realized and unrealized P&L?
Realized P&L is the actual profit or loss from a trade that has been completed and closed. Unrealized P&L is the current profit or loss on a trade that is still open and fluctuating in value with the market.
When does P&L become realized?
P&L becomes realized the moment you close your position, either by selling an asset you bought (in spot trading) or by offsetting a derivatives contract.
Why is the Mark Price used instead of the Last Price?
The Mark Price is used to calculate unrealized P&L to prevent unnecessary liquidations caused by short-term market manipulations or illiquidity that can create abnormal spikes or drops in the Last Traded Price.
Is realized P&L calculated before or after fees?
A true measure of realized P&L must always account for trading fees (and funding rates in perpetual swaps). Your net realized P&L is your gain or loss after all costs are subtracted.
How does realized P&L affect my taxes?
Each time you close a position and realize a gain or loss, it typically creates a taxable event. You are responsible for reporting these realized amounts to the relevant tax authorities according to the laws in your country.
Does transferring crypto between wallets realize P&L?
No. Simply transferring assets from one wallet you own to another wallet you own is not a taxable event and does not realize P&L. P&L is only realized when you trade, sell, or spend the asset.