What Is the Average Annual Return?
The Average Annual Return (AAR) is a simple calculation that divides the total returns by the number of years measured. Investors use it mostly on traditional stock markets to measure the average profits per year relative to the date compared.
In crypto, AAR is only significant when compared with large time frames due to how quickly prices can change.
From the example chart above, Bitcoin has reached a 10-year return of over 120x since 2014. Specifically, prices increased by ~13,400% in 10 years and 1,050% in the past five. After the calculations, Bitcoin would have a 10-year AAR of 1,340% and a 5-year AAR of 105%.
How to Calculate Average Annual Return?
The average annual return definition is straightforward: the return on investment (ROI) between two dates divided by the number of years measured.
ROI (%) = [ (Current Value – Initial investment) / Initial investment ] * 100
AAR (%) = ROI / Total years
Note: In traditional investing, the ROI would be affected by extra elements such as dividends and capital gains distributions (more details on that later). There are equivalents in crypto (e.g., staking rewards, and yield farming platforms). For simplicity, the examples consider only holding crypto assets.
If Bitcoin rises from $20,000 to $60,000 in 3 years, that’s a total ROI of 200%. The 3-Year AAR would be one-third, about +44%.
It’s worth noting that the average annual return meaning isn’t always the same. A positive AAR can still potentially be a bad investment. For example, if three yearly returns are +100%, 0%, and -50%, the AAR is +10% and doesn’t reflect the downtrend.
Elements of Average Annual Return (AAR)
Before calculating averages, annual returns can be added from multiple sources:
Asset Price Appreciation
The asset price appreciation measures the unrealized profit and loss (PnL) of holding a cryptocurrency within that year. Until then, the PnL can greatly change (even between -80% and +200%). For consistent tracking, traders calculate ROI with realized PnL (after selling tokens).
Capital Gains Distributions
Capital gains are profits realized after holding assets for at least one year. Mutual funds typically distribute annual capital gains as a way to spread and reduce taxes overall. US capital gains taxes are 0%, 15%, or 20%, depending on the income bracket.
This can result in unexpected tax bills for users who invest in mutual funds and still haven’t sold anything. Other products (such as Bitcoin ETFs, and exchange-traded funds) don’t have this.
Dividends
Some companies give back to investors part of their quarterly earnings to create a sense of stability and confidence. Similar practices exist in crypto:
- In DeFi platforms, users earn free tokens for locking in their assets for 3-12 months (staking)
- In decentralized exchanges (DEXs), users deposit their tokens temporarily to get a share of the exchange fee revenue
- In real-world-asset (RWA) tokenization, crypto projects may generate revenue with similar business models to real-world companies. For example, buy real estate and distribute the net rental yield with token holders.
Conclusion
The AAR gives a broad overview of how profitable an asset has been in the long term. In the short term, however, crypto yearly returns can deviate a lot from the average. Bitcoin has seen both extremes, from -70% (2018) to +5,500% (2013).
There are similar calculators worth comparing like the Compound Annual Growth Rate. For example, the 10-year Bitcoin ROI of 13,400% is a compounded CAGR of +63% per year. (A much more realistic annual return)
When analyzing AARs, it’s important to review the full data spectrum as well as the recent ROI trend.
WJEC. (2017). Calculating Average Rate of Return (ARR). Wjec.co.uk.
https://resource.download.wjec.co.uk/vtc/2016-17/16-17_1-25/eng/unit1/calculating_average_rate_of_return.pdfÂ
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