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2025-03-30

Yield farming or DeFi interest

Earnings from yield farming or lending crypto in DeFi platforms are taxed as income at the time they are received. However, depositing into and withdrawing from a liquidity pool may be treated as a disposal, which is a capital gains event.

  • Example: Earning £500 in interest from a DeFi platform is subject to Income Tax.

Payments for goods or services

Receiving cryptocurrency as payment for goods or services is treated as income at its market value when received. There are instances where the “value” of the work will be taxed instead of the value of the crypto received. Professional advice should be taken if you are unsure.

  • Example: If you're paid 0.2 BTC for freelance work worth £6,000, this amount is subject to Income Tax.

Receiving airdrops

If you actively participate to receive an airdrop (e.g., completing tasks), the tokens are treated as income at their market value upon receipt.

  • Example: Earning £100 in tokens from an airdrop after completing tasks is subject to Income Tax.

Mining rewards

Mining rewards are taxed as income. Those undertaking mining activities to an extent to which they are operating a business will be subject to additional tax obligations.

  • Example: Earning 0.5 BTC through mining worth £10,000 at the time of receipt is subject to Income Tax.

Staking rewards

Cryptocurrency earned through staking is considered income at the market value at the time of receipt.

  • Example: If you earn 0.1 ETH through staking worth £200, this amount is subject to Income Tax.

Providing liquidity

Adding liquidity: If adding assets to a liquidity pool results in a change of ownership or creates a new token (e.g., LP tokens), it may be considered a taxable disposal, with CGT applying to any gains. The answer to this can usually be found within the terms and conditions of the protocol.

Removing liquidity: Removing assets from a liquidity pool may also be a disposal, potentially triggering CGT based on the gain or loss relative to the cost basis.

Liquidity pool rewards are generally treated as taxable income upon receipt, subject to Income Tax.

Selling airdropped tokens

Selling tokens received through an airdrop is a taxable disposal.

Tokens received without any action (eg, unsolicited distributions) are not taxed as income upon receipt. Instead, they are subject to Capital Gains Tax (CGT) when sold, with the cost basis typically being zero or the fair market value at the time of receipt if explicitly stated by HMRC.

Tokens earned through performing tasks (eg, completing activities) are taxed as income at the market value in GBP upon receipt. When sold, the gain or loss is subject to CGT, calculated using the market value at receipt as the cost basis.

  • Example: You perform a series of tasks to qualify for an airdrop. You then sell that airdropped token for £500 and it has a cost basis of £200. The £200 cost basis would have been subject to income tax in the tax year in which it was received and the £300 gain is subject to CGT in the tax year in which the token is sold.

Selling NFTs

Disposing of NFTs is treated similarly to crypto disposals, with gains subject to CGT.

  • Example: If you bought an NFT for £1,000 and sold it for £3,000, the £2,000 profit is taxable.

Gifting cryptocurrency (excluding spouse or civil partner)

Gifting crypto to someone triggers CGT based on the market value at the time of the gift. Gifting to registered charities or your spouse or civil partner does not trigger a taxable event. Here, we have often seen individuals gifting tokens to others but keeping them in their own wallet. If this is the case, it is very important to document the gift. Consider speaking to a tax advisor if you are uncertain of your position.

  • Example: Giving 1 ETH to a friend worth £2,000 incurs CGT on any gains above its cost basis.

Using crypto to purchase goods or services

Spending cryptocurrency on goods or services is considered a disposal.

  • Example: Paying 0.5 BTC for a laptop is a taxable event. If the BTC had a cost basis of £5,000 but was worth £10,000 at the time of the transaction, the £5,000 gain is subject to CGT.

Crypto-to-crypto trades (swaps)

Exchanging one cryptocurrency for another (e.g., BTC for ETH) is treated as a disposal for tax purposes.

  • Example: Swapping BTC worth £5,000 for ETH creates a taxable event, with any profit based on the cost basis of your Bitcoin. The value of the BTC when swapping will be the proceeds and will also become the cost of the ETH that has been obtained.

Selling crypto for GBP

Any profit made when you sell crypto for fiat currency (e.g., GBP) is a taxable event.

  • Example: If you bought BTC for £10,000 and sold it for £15,000, you have a taxable gain of £5,000.

How Investing vs Trading impacts tax

In most cases of buying and selling cryptocurrency as a retail investor, you are participating in investing rather than trading. The two are treated differently for tax purposes.

  • Investing is subject to capital gains tax or income tax, depending on the nature of the transaction.
  • Trading in this case refers to self-employment which is subject to income tax and National Insurance Contributions.

The key difference between investing and trading – along with the different tax treatments, is how losses generated in the crypto-activity can be used.

In their guidance, HMRC have explicitly stated that they would expect it to be exceedingly rare that any crypto-activity constituting buying & selling crypto would be classified as “trading”.

If you are uncertain, speak to a tax advisor as there are always exceptions, including but not limited to, developing tokens and large scale mining.

How is crypto tax calculated in the United States?

You can be liable for both capital gains and income tax depending on the type of cryptocurrency transaction, and your individual circumstances. For example, you might need to pay capital gains on profits from buying and selling cryptocurrency, or pay income tax on interest earned when holding crypto.

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United Kingdom
Guides
30
 
Mar
 
2025
 - 
10
min read

Liquidity Pools and LP tokens – How to calculate your taxes

A guide to liquidity pools, LP tokens and how to report them on your taxes.

Key takeaways
  • Adding and removing assets to a liquidity pool is typically a taxable event.
  • The taxable event occurs because you exchange two or more assets for a liquidity pool token, which is similar to a trade for tax purposes.
  • Impermanent Loss (IL) means that the exact assets you deposited, may not be the exact assets your receive when you withdraw.
This tax guide is regularly updated: Last Update  
CryptoTax Calculator thumbnail

Liquidity pools and LP tokens are the backbone of decentralized finance (DeFi).

They have enabled a whole host of innovative financial products.

Liquidity pools enable token swaps , borrowing and lending protocols, yield farming and aggregators, on-chain liquidity insurance and many other products.

But with this innovation has come new complexity with tax reporting and calculations.

In this guide we explain how liqudiity pools work, and how to calculate the associated taxes.

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What is a liquidity pool?

A liquidity pool is essentially a group of tokens or assets locked into a smart contract to enable decentralized token swaps, lending, borrowing, and other activities, all on-chain.

Each liquidity pool will have a specific composition of assets (usually 2-3 specific tokens) where the amount of Token A + Token B = 'LP AB', and liquidity providers must deposit equal proportions (in market value) of each token to enter the pool.

Liquidity pools form the backbone of decentralized exchanges (DEXes) such as Uniswap, Pancakeswap and Raydium.

Unlike a centralized exchange, DEXes do not use an order book to create the market price.

When you place a buy order on a centralized exchange, you choose the price you want to purchase the asset for, and when that order gets filled, there is a seller on the other side who placed an order and was happy to sell you the asset at the same price, your order gets filled.

Instead, automated market makers (AMMs) govern the liquidity pools in DeFi, and algorithmically balance the pools to determine the price.

Example:

Let's take a theoretical liquidity pool on Uniswap that consists of 100,000 ETH and 10,000 WBTC. This would be a ETH-WBTC Liquidity Pool (LP).

This gives an initial price ratio of 1 ETH : 0.1 WBTC. Let's say that the price of ETH on some major exchanges, such as Binance and Coinbase, starts to fall below this ratio, down to 1 ETH : 0.09WBTC.

There is now an arbitrage opportunity between the centralized exchanges and the Uniswap crypto liquidity pool.

ETH would be purchased from the centralized exchanges and sold to the pool for an immediate profit.

This selling would rebalance the liquidity pool, adding ETH and removing WBTC until an equilibrium is reached between the centralized exchange price and the decentralized liquidity pool price, meaning arbitrage would no longer be profitable.

In practice, this happens constantly and is why the price of assets is generally very similar to the prices on large exchanges.

The Process of Providing Liquidity

If you have decided you want to participate in this innovative new financial product, and take the risk of impermanent loss in exchange for the chance of returns from trading fees, you will have to go through the process of providing liquidity.

The first step is to decide what pool you want to join. This will mainly be factored by what tokens you own, and are willing to give liquidity pool tokens for a return. Examples of popular liquidity pools are: ETH/USDC, ETH/WBTC, ETH/DAI etc.

The second step is to decide what platform you want to trust with your tokens. Certain platforms are more battle-tested than others, and have possibly had their code audited for bugs or flaws.

Some liquidity pools may have incentive schemes to entice you to join the liquidity pool, especially if the pool is new. It is important to note that your funds are only as safe as the contract you deposit them into.

Note: Brand new protocols will generally be more risky than larger, well-known, audited ones! However, there is a risk with any DeFi protocol, so think carefully before deciding to join a LP.

The third step is to provide the liquidity using your web3 wallet, such as MetaMask. The pool will require you to deposit set proportions of each token at the time of deposit, e.g. 1 ETH : 5000 USDC for the ETH/USDC Uniswap liquidity pool.

In return, you receive a proportional amount of LP tokens associated to that liquidity pool. These tokens represent your stake of the pool.

The last step is when you want to redeem your LP token, and withdraw your funds from the pool. In the redeeming process, you essentially exchange the LP token back to the liquidity pool in return for your stake (plus your share of the fees that were generated over that time period).

If no impermanent loss has occurred, you will walk away with the same amount of each token as you deposited. If there has been some IL, you may receive different proportions of the tokens you first deposited.

Impermanent Loss

The problem that the constant rebalancing causes for crypto liquidity pools and liquidity providers is a concept called impermanent loss (IL).IL occurs when one of the assets in the pool appreciates against the other.

In the example above, where WBTC has appreciated against ETH, the liquidity providers of this pool have essentially lost some WBTC exposure as the arbitragers have removed WBTC from the pool and added ETH.

The loss is 'impermanent', as it may return to the same allocation of assets if the price returns to the same proportion as when the liquidity provider entered the liquidity pool.

To compensate liquidity providers for taking the risk of IL, traders who make trades using the liquidity pool must pay a trade fee, which gets allocated to the liquidity providers. The more trades that get made, the higher the return is in % terms for liquidity providers.

How are liquidity pools taxed?

The process of providing liquidity, and the resultant LP tokens and their properties are a grey area in most tax jurisdictions. It is important that you discuss these transactions in-depth with your personal accountant so they can take into consideration your personal situation, and how these transactions may affect your tax obligations.

When you deposit your tokens into the pool, effectively you are 'disposing' of the tokens (relinquishing control of them) and receiving a Liquidity pool (LP) token, with substantially different properties, in return.

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Categorizing Liquidity Pools on Crypto Tax Calculator

From the guidelines we have received, our platform categorizes this initial deposit into the liquidity pool tokens as a 'Add Liquidity'. The receipt of the liquidity pool (LP) token is categorized as a 'Receive LP Token'.

This creates a taxable event on our platform, where you may realise capital gains from the 'Add Liquidity' of the deposited tokens, as some tax jurisdictions treat this as a capital disposal event.

This can be seen in the example below, where pxGMX and ETH digital assets have been deposited into a liquidity pool on Arbitrum's Camelot DEX:

liquidity-pool-ctc-example-1.png

You can see the deposit of each asset, pxGMX and ETH, digital assets have been categorized as 'Add Liquidity' and have an associated capital gain/loss.

This is then immediately followed by the receipt of the Camelot LP token, which is assigned a value equal to the value of the two deposited tokens. As there is a fee for this transaction, a small capital loss is associated on the right.

The redemption of the LP token works in the reverse process, with the LP token being categorized as a 'Send LP Token' and the deposited tokens (plus generated fees/yield) being received being categorized as a 'Remove Liquidity’.

If the LP position has changed in value between the initial deposit and the final withdrawal, this will be classified as a taxable event depending on your tax jurisdiction.

This can be seen again in the example where pxGMX and ETH has been withdrawn from the same liquidity pool on Arbitrum's Camelot DEX:

liquidity-pool-ctc-example-2.png

You can see the send of the Camelot LP token, which is assigned a value equal to the value of the two deposited tokens. This is then immediately followed by the withdrawal of each crypto asset, pxGMX and ETH.

The Crypto Tax Calculator platform has automatically categorized these as 'Remove Liquidity' and have an associated capital gain/loss.

As mentioned before, crypto liquidity deposits are a grey area in most tax jurisdictions. Crypto Tax Calculator uses the method outlined above, where each step of the liquidity provision is a taxable event. This ensures our users are best positioned for future clarification of these complex transactions. If this is to be clarified as a chain of taxable events in the future (as the platform accounts for) users will be positioned correctly in terms of their tax obligations. If we were to take the stance that this was not a chain of taxable events, and future clarification went against this assumption, many of our users would be impacted and have unfulfilled tax obligations.

Again, it is very important you clarify this process of events with your accountant to ensure your taxable obligations are fulfilled in your particular personal circumstance.

LP Token Value

As there are millions of different liquidity pools, each with their own unique LP token associated, and with their own unique pool characteristics, it is not always possible for us to assign a market value to your LP token at this point in time.

Each LP token will change value every single time a trade is executed in the liquidity pool, or when liquidity is added or removed, and thus, the proportion of the pool that the LP token represents is ever-changing.

This explains why it is currently difficult to assign a correct market value to your LP token. The LP token will be assigned the value of the deposited tokens at the time of deposit, and will only receive a new value at the time of withdrawal, equal to the value of the withdrawn tokens at that time.

This is how capital gains and losses are accounted for, but may result in incorrect 'holdings value' on the dashboard whilst you have this LP token in your possession.

The information provided on this website is general in nature and is not tax, accounting or legal advice. It has been prepared without taking into account your objectives, financial situation or needs. Before acting on this information, you should consider the appropriateness of the information having regard to your own objectives, financial situation and needs and seek professional advice. Crypto Tax Calculator disclaims all and any guarantees, undertakings and warranties, expressed or implied, and is not liable for any loss or damage whatsoever (including human or computer error, negligent or otherwise, or incidental or Consequential Loss or damage) arising out of, or in connection with, any use or reliance on the information or advice in this website. The user must accept sole responsibility associated with the use of the material on this site, irrespective of the purpose for which such use or results are applied. The information in this website is no substitute for specialist advice.

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