Money Today is Worth More: How to Understand Current Value in Finance

TL;DR The concept of the time value of money (TVM) assumes that receiving a certain amount today is more beneficial than obtaining the same amount in the future. The foundation of this phenomenon is the possibility of investment and generating returns. TVM analysis involves calculating the present value of future cash flows and the future value of present capital. This concept has direct applications in the world of cryptocurrencies, where regular investment decisions require comparing available options over time.

Why Does Time Change the Value of Our Money?

Every person has a different attitude towards money. While some focus on saving, others prefer to invest immediately. Regardless of individual approaches, there is a universal financial principle governing how we should evaluate money received at different points in time.

Let's imagine a practical situation: we lent someone 1000 dollars. This person offers us to return it today or the same amount in a year. Intuitively, we would choose the first option. However, justifying this decision leads us to the concept of opportunity cost - the money received now could be placed in a savings account, invested in the stock market, or used in another profitable way. Additionally, inflation causes the real purchasing power of the same amount to decrease over time.

Two Pillars of Analysis: Current and Future Value

To systematically analyze financial decisions, economists have developed two complementary approaches.

Current Value (Present Value - PV) answers the question: how much is the sum we will receive in the future worth today? In other words, what is the discounted value of future money considering the market rate of return? This analysis helps us assess whether it is worth waiting for future inflows.

Future Value ( - FV) takes us in the opposite direction. It takes the amount available today and calculates how much it will be worth at a specified point in the future given a certain rate of return. This is an essential tool for long-term planning.

Calculating Future Value: How Our Capital Grows

Let’s assume we have 1000 dollars and we have an investment opportunity with a 2% annual return rate. After one year, our investment will be worth:

FV = 1000 $ × 1.02 = 1020 $

If we extend the investment period to two years, the calculation changes:

FV = 1000 $ × 1.02² = 1040.40 $

The general formula for future value takes the form:

FV = I × (1 + r)^n

Where: I is the initial investment, r is the interest rate, and n is the number of periods.

Knowledge of future value allows us to plan financially - we know how much capital invested today can grow over a specified time horizon.

Reverse Operation: Calculating Present Value

Sometimes we face the opposite problem. Suppose someone offers us 1030 dollars in a year instead of 1000 dollars today. Should we accept this offer? Calculating the present value gives us the answer:

PV = 1030 $ ÷ 1.02 = 1009.80 $

Since the present value of the future sum (1009.80 $) is higher than what we would receive today (1000 $), the proposal to wait a year is financially reasonable. The offeror indeed adds an additional $9.80 in value to us.

Mathematically, the present value is calculated according to:

PV = FV ÷ (1 + r)^n

These two operations - calculating FV and PV - are the heart of TVM analysis.

Compound Interest Storage Effect

In our previous examples, we assumed annual compounding. In reality, interest can be accrued more frequently - quarterly, monthly, or even daily. Each additional compounding generates a “snowball effect,” where the earned interest starts earning interest itself.

The formula taking into account multiple storage looks as follows:

FV = PV × (1 + r/t)^n×t

Where: t is the number of storage periods in a year.

With the same 2% per year and 1000 dollars:

• Annual storage: _FV = 1000 × (1 + 0.02/1)^1 = 1020 $
• Quarterly storage: _FV = 1000 × (1 + 0.02/4)^4 = 1020.15 $

The difference seems minimal, but with large amounts and over longer periods, the difference becomes significant.

Inflation: The Hidden Player in the Financial Game

All previous calculations did not take inflation into account. What is the use of a 2% annual return when inflation is 3% per year? In reality, we are losing purchasing power.

Inflation is difficult to measure and predict accurately. There are many indices tracking price increases that can provide different results. Future inflation remains uncertain, making it challenging to incorporate it into precise TVM calculations.

In practice, many wage negotiations are based on taking inflation into account in the proposed rates. For investors, this means the necessity of choosing the real (inflation-adjusted) rate of return instead of the nominal one.

Practical Application of TVM in the World of Cryptocurrencies

Cryptocurrencies offer many scenarios in which we must choose between assets available now and future benefits.

Staking and locking assets is a classic example. An investor can choose between holding one ETH (Ethereum) today or locking it in a staking protocol to receive it back in six months with an interest rate of 2%. TVM can help us assess whether this rate is attractive enough compared to alternative investment opportunities.

Similarly, the decision to buy Bitcoin (BTC) is based on assumptions about future value growth. Although BTC is referred to as a deflationary currency, its supply is still increasing - it currently exhibits inflationary characteristics. Is it better to buy BTC for 50 dollars today or wait a month? TVM would suggest the first option, although the price volatility of BTC makes the scenario more complicated than classic financial calculations.

The current value of future staking profits can be calculated by comparing the offered interest rate with the alternative cost of capital - in other words, how much we would earn if we invested in other assets instead.

When TVM Becomes Essential

For ordinary investors, TVM operates intuitively. Most people understand that it's better to have money today than tomorrow.

For large institutions, investment funds, and lenders, even a fractional percentage difference in the present value assessment has a huge impact on profitability and strategic decisions. Formal TVM calculations are the industry standard.

For a crypto investor, introducing TVM into the decision-making process allows for a more systematic comparison of available options - whether it's choosing between different staking products, timing purchases, or assessing the profitability of various DeFi protocols. In a world where every percentage of return has real value, understanding the mechanics of the time value of money becomes an essential tool.