How to apply the Rule of 72 in the crypto industry?

What is the Rule of 72?

The Rule of 72 stems from traditional finance and refers to a quick formula used to estimate the number of years required to double the invested money at a certain annual rate of return or to calculate compound interest rates. 

This formula is often taught to beginners as a supplement to spreadsheet programs and calculators. It comes in handy for calculating anything that increases exponentially such as inflation rates or GDP as well as the long-term effect of annual fees on the investment growth.  

However, the Rule of 72 formula mainly works on compounded rate of return and it is accurate in the rate of return range of 6% and 10%. In other words, with the rate of return diverging, the results could deviate from the calculation.

Therefore, investors choose other rules for different calculations such as the Rule of 69, Rule of 70 or Rule of 73. Seasoned investors tend to use the Rule of 69.3 suggesting it produces more accurate results in relation to continuous compound interest rates.

For example, for rates of return ranging from 6% to 10%, the Rule of 72 shows up as the most accurate. For looking at potential returns of less than 6%, the Rule of 72 turns into the Rule of 71, and at rates higher than 8%, investors typically add 1 for every 3 percentage points.

A little bit of history

As mentioned above, the Rule of 72 has its origin in traditional finance and it has been used for a long time. The earliest reference points to a 15th-century Italian mathematician Luca Pacioli.  

Back in 1494, Pacioli referenced the formula in his comprehensive mathematics book Summa de Arithmetica where he discussed the rule concerning the doubling time of investments. Since Pacioli didn’t explain the derivation, it is believed that the rule predates his book and that he was building on the predecessors' work.

How to calculate the Rule of 72 formula?

The Rule of 72 is a simplified formula- just divide the number 72 by the desired asset's annual return, and you will get the number of years needed to double your investment.  

If your investment vehicle provides an 8% annual compounded rate of return, dividing 72 by 8 means that it will take 9 years to double the invested money. 

For example, you have invested $50,000 in a mutual investment fund with a 6% average rate of return. If you use the formula, your calculation should look as simple as this: 72/6=12. In other words, at a 6% annual rate of return, your investment could double in value in approximately 12 years.  

As you can see from this simple calculation, the main element of the rule is that the rate of return remains stable for years and that it provides only an approximate estimate of the time needed for your initial investment to double. 

If you add the changing market dynamics, economic performance, and inflation rates, it is obvious that returns could vary throughout the years. 

How to use the Rule of 72 as an investment strategy?

The application of the Rule of 72 goes beyond simple investment calculations. It is useful in estimating exponential growth rates in various other contexts such as population growth, and inflation rates, and even in estimating the exponential growth of computing power or the spread of new technologies. 

Let's take a look at how the Rule of 72 can help you determine your investment strategy

Calculate the effect of fees on investment gains

This presents an interesting area where the Rule of 72 is used as an estimation tool to calculate the effect of fees on investment gains.  

For example, let’s say that a hypothetical mutual fund charges 2% annual expense fees that could reduce the investment principal to half in 36 years.  

To calculate the number of years that would reduce the initial principal, we use this formula: time in years (n)=72/2=6. If the fees increased to 3%, then the answer would be 24 years. 

Many concepts that stem from the traditional financial system found their place within the crypto world. If you're interested in finding out how crypto hedge funds function, why not read this article: 'A guide on crypto hedge funds'.

Calculate the inflation rate and its effects

This Rule is also used to calculate the effect of inflation on your investment which is quite useful given that inflation presents a problem that diminishes the purchasing power of money over time. With the Rule of 72, you can calculate how much time it would take for a portfolio to halve in purchasing power. 

You need to divide 72 by the inflation rate and you will get an estimated number of years. For example, if you want to find out what effect a 4% inflation rate could have on your deposited fiat money, just divide the number 72 by the inflation rate. The answer is that it will take approximately 18 years for the purchasing power of the deposited money to halve.

Debt repayment

Even though the Rule of 72 is generally used to estimate growth, the calculation can be flipped to estimate how long it would take you to pay off your debt in case you make fixed monthly payments. Here are some key takeaways.

To get the results, just divide 72 by the monthly interest rate in the form of a percentage and you’ll get a rough estimation of the pay-off time frame.

Concerning debt issues, you can also calculate the time in which the owed amount will double. For example, if you have a credit card debt with an annual interest rate of 20%, you will get the result that the owed amount will double in roughly three and a half years.

The application of the Rule of 72 formula in the crypto market

When people think of the crypto market, volatility is one of the first things that comes to mind. Even traditional cryptocurrencies such as Bitcoin and Ethereum had broad price movements which either led to big gains or losses. The Rule of 72 is all about predictability, yet the volatile crypto market makes it sometimes hard to predict accurate returns and apply this simple rule. 

For example, if a certain crypto asset has a projected annual growth rate of 10%, the Rule of 72 states that it should take 7.2 years to double the investment. Since the calculation doesn’t consider broad market swings, the results could be inaccurate. 

To make informed decisions within the crypto space, it is crucial to understand that the prices of crypto assets are influenced by a wide array of elements such as regulatory changes, market sentiment, geopolitical events and technological innovations. Therefore, it is advisable to use the Rule of 72 with caution, knowing crypto markets don’t always align with traditional financial patterns.

How does the Rule of 72 work in the crypto space?

Even though the volatile crypto market is not a perfect environment for the use of the Rule of 72, it is still being implemented by investors.  

Crypto traders and investors are engaged in using several sophisticated strategies and quantitative models that consider a wide array of indicators and variables, but an adjusted rule can still be implemented. 

For example, investors can modify the number 72 by adding or subtracting 1 for every three-point deviation from the primary interest rate or use variations of the Rule of 72 for scenarios involving continuous compounding. 

To navigate the crypto investing landscape efficiently, take a look at this article: 'Five tips for crypto investing (and staying sane)'.

Why isn't it more common in crypto investing?

The reason why this rule isn’t more discussed or taken into consideration in the crypto world is because of the nature of the cryptocurrency market. Given that it is speculative by nature and driven by price fluctuations, it is not an easy task to get accurate results. 

Is speculation a truly negative concept? Learn more by reading this article: 'Does crypto need speculation? Why crypto bettors aren't all that bad'.

However, this rule still provides a basic scheme for comprehending investment growth but its application in crypto markets still requires a supplementary analysis and a firm understanding of the market dynamics.

The bottom line

Whether the Rule of 72 could be used more effectively in the field of cryptocurrency investments is still unclear. It is believed that the demand for predictable growth strategies and calculations could increase as more and more investors seek stability in this dynamic market. 

On the other hand, the Rule of 72 comes in handy to beginner investors and helps in understanding the power of compound interest and how investments can grow over time.

Given that several studies demonstrate that many people lack basic financial knowledge, this simple formula can be a good starting point for grasping basic financial concepts.  

Whether you’re into crypto or traditional investing, demonstrating financial responsibility and knowledge, along with conducting thorough research is a powerful force for eliminating potential risks. Using the rule cannot be a replacement for professional advice, but it can enhance your financial literacy and the ability to make informed decisions in the future. 

As we have pointed out multiple times, education is a must when dealing with crypto assets. If you are a newbie in the crypto market, check out available courses on our Learn Crypto Academy.