Cost basis is the original value of an investment or crypto asset — what you paid to acquire it — plus any additional costs like transaction or gas fees. It represents your total “starting cost” and serves as the reference point for calculating gains or losses when you sell, trade, or otherwise dispose of the asset.
In simple terms:
Proceeds − Cost Basis = Capital Gain (or Loss)
Why Cost Basis Matters in Crypto
For crypto investors, accurately tracking cost basis is essential for understanding your real profit and staying compliant with tax rules. The IRS treats cryptocurrency as property, meaning each sale or swap can trigger a taxable event. If your records are off — or if you forget to include gas or exchange fees — your reported gains can be overstated.
Cost basis tracking also affects how much tax you pay:
- A higher cost basis reduces taxable gains.
- A lower cost basis increases taxable gains.
- Each purchase or transfer can create a new “lot” with its own cost basis and holding period.
That’s why having a tool like Merlin automatically record every purchase, swap, or transfer — and link it to your acquisition cost — gives you an accurate view of your true performance and tax exposure.
Example
You buy 2 ETH for $3,000 and pay $50 in transaction fees.
Your total cost basis for that lot is $3,050.
If you later sell the 2 ETH for $4,000, your taxable gain is:
$4,000 − $3,050 = $950
If you received tokens as staking rewards worth $500, that fair market value becomes your cost basis — even though you didn’t purchase them.
Cost Basis Methods
When you own multiple lots of the same crypto, different accounting methods can change which coins are considered “sold” first. The most common are:
- FIFO (First In, First Out) — Oldest coins sold first.
- LIFO (Last In, First Out) — Most recent coins sold first.
- HIFO (Highest In, First Out) — Coins with the highest cost basis sold first, often minimizing gains.
Why It’s Important for Your Exit Strategy
Understanding your cost basis isn’t just about taxes — it’s central to planning your exit strategy. Knowing exactly how much profit a sale will generate after accounting for acquisition costs and taxes helps you set smarter price targets, allocate sell percentages, and track real returns in dollars — not just percentages.