Realized and Unrealized Gains: Differences, Calculation Formulas, Examples

The concepts of realized and unrealized gains play a crucial role in assessing the efficiency of investments. However, many novice investors do not fully grasp the essence of these categories and mistakenly consider them identical. In reality, realized and unrealized gains have significant differences that are important to understand in order to make informed investment decisions.

Let's examine the stages of profit formation from investments to understand how the actual investment result is derived from the conditional assessment of the current value of positions. Then, we will focus on the key differences between realized and unrealized gains, which are significant to consider in investment practice. This will enable the reader to comprehend the essence of these financial categories and evaluate the efficiency of their own investments more soundly, avoiding risks associated with their inaccurate understanding.

What is Realized Gain?

Realized gains are the difference between the purchase price of a cryptocurrency and the price at which it is subsequently sold, expressed in monetary terms. In other words, it is the specific amount of money an investor has gained from cryptocurrency investments.

Realized gains only occur after the investor has sold their crypto assets. While they are in the investor's possession, any changes in their market value are considered unrealized gains or losses. These gains can fluctuate depending on price changes in the cryptocurrency market.

To calculate realized gains, you use the purchase price of the cryptocurrency asset and its selling price. The difference between these prices in monetary terms indicates how much money the investor has earned or lost from that transaction. Realized gains serve as an objective assessment of the success or failure of a specific cryptocurrency investment.

What is Unrealized Gain?

Unrealized gain is the potential value of cryptocurrency assets in an investor's portfolio, calculated based on current market prices but not locked in by a specific buy or sell transaction. Unlike realized gain, which can be converted into cash after selling the assets, unrealized gain is merely a theoretical estimate.

To calculate unrealized gain, you compare specific coins and tokens' purchase prices to their current market value. If the price is higher than the purchase price, then there is an unrealized gain. However, as long as the assets are not sold, this gain exists only on paper and can turn into losses if the prices decline at any point.

Many investors track the size of unrealized gains to assess the effectiveness of their current investments. Still, to convert them into actual funds, you need to carry out a realization operation – selling cryptocurrency assets. Only after that does the potential gain become an actual, realized amount received by the investor.

What are the Differences?

Realized and unrealized gains are two important concepts in cryptocurrency investment. Understanding the differences between realized and unrealized gains is crucial for any cryptocurrency investor. Otherwise, there is a risk of drawing inaccurate conclusions about investment results.

Many novice investors mistakenly believe that unrealized gains are already earned money. However, this does not account for market volatility and the possibility of future price declines. Such “gains” require confirmation through asset sales.

Without understanding the distinction between these terms, assessing investment effectiveness, setting stop-loss orders correctly, and realizing profits is difficult. Additionally, this can lead to incorrect tax reporting.

Therefore, anyone investing in cryptocurrencies should thoroughly understand the nature of realized and unrealized gains to make informed investment decisions. This will enable them to achieve maximum efficiency from their investments.

Realized gain is the profit an investor obtains after selling crypto assets at a higher price than the purchase price. This gain is already credited to the investor's account and can be freely spent or reinvested.

Unrealized gain, on the other hand, is only potential, conditional profit calculated based on current market prices. A real transaction is needed to lock in this gain. Furthermore, unrealized gains can fluctuate depending on market dynamics and are not guaranteed.

In summary, the key difference is that realized gain is money that has already been credited to the investor's account, while unrealized gain is currently only potential income, subject to market fluctuations.

How to Use Realized and Unrealized Gains in Investment Analysis?

Effective analysis of cryptocurrency investments is impossible without taking into account realized and unrealized gains. These metrics provide valuable information about the efficiency of your strategy and allow you to refine your decision-making process.

Realized gains characterize the actual income from investments, and comparing them to the amount of capital invested shows the real return on investment. Unrealized gains are monitored for timely action; their growth signals the need to lock in profits, while a decline may require setting stop-loss orders.

By comparing these metrics over different periods, you can assess the effectiveness of your trading decisions and identify errors in your strategy. By studying the relationship between the maximum unrealized gain and the realized profit, an investor can enhance their skills in “capturing” market peaks.

Such a detailed analysis of realized and unrealized gains allows for continuous improvement of your investment tactics and achieving maximum profitability in cryptocurrency investments.

For effective investment analysis, it is essential to account for the difference between realized and unrealized gains correctly. Investors should regularly track these metrics and compare them.

In the long run, tracking the total amount of realized gains is crucial to assess the success of your chosen investment strategy.

Additionally, it's beneficial to compare the returns from cryptocurrency investments with the returns from other assets for benchmarking purposes. All of these practices help you develop an optimal strategy for managing your investment portfolio.

Clear quantitative and qualitative analysis of realized vs. unrealized gains provides valuable data for making well-informed managerial decisions.

Formula for Calculating Realized Gain

Realized gain reflects the actual income of an investor from selling cryptocurrency. It is calculated as the difference between the revenue from the sale and the initial costs of purchase.

The formula for calculating realized gain is as follows:

Realized Gain (RG) = Revenue from Sale (R) - Initial Investment (I)

Where:

• RG — realized gain
• R — revenue from the sale of assets
• I — initial investment

Example 1:

An investor purchased 1 BTC at a price of $8,000.

One month later, they sold the BTC for $10,000.

I = $8,000

R = $10,000

RG = R - I = $10,000 - $8,000 = $2,000

Example 2:

An investor purchased 10 ETH at a price of $200 each.

One year later, they sold 8 ETH at a price of $500 each.

I = 10 ETH * $200 = $2,000

R = 8 ETH * $500 = $4,000

RG = R - I = $4,000 - $2,000 = $2,000

This formula allows you the precise calculation of the actual income from cryptocurrency investments after realization.

Formula for Calculating Unrealized Gain

Unrealized gain reflects the potential income from cryptocurrency investments, but unlike realized gain, it depends on current market prices and can change.

The formula for calculating unrealized gain is as follows:

Unrealized Gain (UG) = Current Market Value (CMV) - Initial Investment (I)

Where:

• UG — unrealized gain
• CMV — current market value of the portfolio
• I — initial investment

Example 1:

An investor purchased 1 BTC at $8,000.

The current price of BTC is $10,000.

I = $8,000

CMV = 1 BTC * $10,000 = $10,000

UG = CMV - I = $10,000 - $8,000 = $2,000

Example 2:

An investor purchased 10 ETH at $200 each.

The current price of ETH is $300.

I = 10 ETH * $200 = $2,000

CMV = 10 ETH * $300 = $3,000

UG = CMV - I = $3,000 - $2,000 = $1,000

This formula allows you to calculate potential income at any time based on market dynamics.

How are Realized and Unrealized Gains Taxed?

In the US, cryptocurrency gains are subject to capital gains tax. For realized gains, where an individual sells a cryptocurrency for a fiat currency like US dollars, they incur a capital gains tax. The capital gains tax rate depends on the taxpayer's income and how long the crypto assets were held. If held for over a year, the rate is 0%, 15%, or 20% depending on income. 

However, unrealized gains, where the value of crypto increases but remains in the portfolio and is not sold, are not taxed that year. Tax is only owed when those crypto assets are disposed of in a taxable transaction like selling. This differs from other investment assets like stocks that may incur estate or gift taxes on unrealized gains in some situations. So, in summary, in the US, realized crypto gains attract capital gains tax, while unrealized gains do not generate an immediate tax liability. Tax is paid once cryptocurrency profits are cashed out.

Why Track Unrealized Gains and Losses?

Monitoring the dynamics of unrealized gains and losses plays a crucial role in effective portfolio management. While this metric does not reflect the actual financial outcome, it allows for timely responses to market changes.

By monitoring the current value of unrealized gains and losses, investors can make tactical decisions promptly: realizing gains at their peak or locking in losses when prices decline.

Comparing its dynamics to historical extremes can provide better market movement forecasts. Tracking losses at an early stage can contribute to reducing losses through position adjustments.

Only through constant monitoring of the sizes of potential gains and losses can an investor optimally manage their portfolio in conditions of market volatility.

How Can MetaTracker Help?

Users can synchronize transaction data with cryptocurrency exchanges in their MetaTracker account. Based on information about purchase and sale prices, MetaTracker automatically calculates realized financial results.

The system also tracks the current market value of the entire portfolio. Continuous comparison of this data with initial investments allows for the prompt assessment of the size of unrealized gains.

Thanks to the user-friendly visual interface of MetaTracker, investors can analyze the dynamics of both realized and potential gains at any time. This helps in making well-informed management decisions.

In summary, the service automates complex calculations and makes the analysis of investment results as convenient and transparent as possible.

Conclusion

Calculating realized gains allows you to assess the actual financial outcome of transactions accurately. Monitoring unrealized gains provides insight into the current portfolio value and potential earnings.

Tracking these metrics, along with analyzing market dynamics, helps investors respond promptly to changes in the prices of digital assets. Properly applying the formulas for calculating realized and unrealized gains is an important component of safe and profitable cryptocurrency investing in the face of its high volatility.