The Comprehensive Guide to DeFi Taxes (2024)

Trying to report your DeFi taxes can be stressful and confusing. 

In this article, we’ll break down everything we know about how common DeFi transactions are taxed – including lending, borrowing, yield farming, liquidity pools, and earning. We’ll also cover the tax implications of some of the most popular DeFi protocols.  

CoinLedger has helped more than 500,000 investors file their cryptocurrency and DeFi taxes. This guide was reviewed by our in-house team of tax experts before publication and is updated regularly based on new IRS guidelines.

How is cryptocurrency taxed?

In the United States, cryptocurrency transactions — including DeFi transactions — are typically subject to capital gains tax and income tax.

Capital gains: When you sell, exchange, or otherwise dispose of your cryptocurrency, you incur capital gains or capital losses depending on how the price of your crypto has changed since you originally received it. 

Ordinary income: When you earn cryptocurrency through any means whether that is through mining, staking, or various forms of interest, you recognize income based on the fair market value of the cryptocurrency at the time of receipt. 

If you don’t know how crypto is taxed, we recommend starting out with our article: The Complete Guide To Cryptocurrency Taxes.

What is decentralized finance (DeFi)?

DeFi, short for decentralized finance, is an area of cryptocurrency focused on enabling access to financial services such as trading, lending, and borrowing without incurring the costs or delays associated with traditional rent-seeking middlemen (i.e. banks, financial institutions, etc).

While many popular DeFi applications are on the Ethereum ecosystem, others exist on chains such as Solana and Avalanche. Some unique technological advancements such as Automated Market Making (AMM) and Liquidity Pools enable the “decentralized” capabilities of many of the most popular DeFi platforms today. 

How is DeFi taxed? 

While the IRS has not released any direct guidance on DeFi specifically, they have released general guidance on cryptocurrency. From these guidelines, we can infer that DeFi transactions are subject to capital gains tax or income tax in most cases. 

It’s important to note that because of the lack of clear guidance on DeFi, there may be ‘gray areas’ when it comes to how certain specific transactions are taxed. If you’re not sure how to report your DeFi transactions, you should reach out to your tax professional. 

Can DeFi be used for tax evasion? 

Because decentralized finance currently does not require Know Your Customer (KYC) information, many assume that the government cannot track DeFi transactions. However, the IRS can track on-chain transactions.

Transactions on blockchains like Bitcoin and Ethereum are publicly visible and permanent. In the past, the IRS has worked with contractors like Chainalysis to analyze the blockchain and crack down on tax fraud. 

With mandatory 1099 reporting coming in the near future, the IRS will soon have more resources at hand to crack down on tax evasion taking place through DeFi protocols. 

Do DeFi protocols report to the IRS? 

At this time, most DeFi protocols do not report to the IRS. However, this is likely to change in the near future. 

The infrastructure bill, signed by President Biden in November 2021, requires that any party that facilitates a cryptocurrency transaction provides 1099 tax reporting information to the user and the IRS. 

According to Treasury Department guidance, it’s likely that decentralized exchanges will be roped into being required to report tax information via Form 1099-DA starting in 2026. Soon, decentralized exchanges and protocols may be required to collect KYC information to continue to legally operate in the United States. 

How is liquidity mining taxed? 

Depositing liquidity in a liquidity pools: Capital gains  

Depositing liquidity in a liquidity pool and receiving LP tokens in return may be considered a crypto-to-crypto trade subject to capital gains tax. 

Example:

You own ETH worth $1,500. 

The price of your ETH rises to $1,800. 

You deposit your ETH in a liquidity pool and receive an LP token in return. 

You incur a capital gain of $300. 

Withdrawing liquidity in a liquidity pools: Capital gains tax 

When you withdraw liquidity, you’ll likely be required to trade your LP tokens to regain access to your cryptocurrency. It’s likely that this will be also considered a crypto-to-crypto trade subject to capital gains tax. 

Example:

You deposit $2,000 of ETH and WBTC in a liquidity pool and receive LP tokens. 

The price of your share of the liquidity pool rises from $2,000 to $3,000. 

You withdraw your share of the liquidity pool and incur $1,000 of capital gain.

The IRS has not released any guidance about providing liquidity to liquidity pools. While the conservative approach highlighted above is recommended, some investors choose to take a more aggressive approach. 

Conservative approach: Treat exchanging cryptocurrency for LP tokens as a crypto-to-crypto exchange. You’ll incur capital gains or losses depending on how your crypto has changed since you originally received it. 

Aggressive approach: Treat exchanging cryptocurrency for LP tokens as equivalent to a deposit, which is considered a non-taxable event. This stance argues that true tax ownership is not transferred upon creation of LP tokens.

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How is DeFi staking and interest taxed? 

DeFi staking and interest rewards may be taxed as income or capital gains depending on the specific mechanisms of your protocol. 

Earning new tokens: Income 

If you earn rewards in the form of new tokens in your wallet, your rewards will be taxed as income based on the fair market value of your crypto at the time of receipt. 

Example:

You earn $300 in stablecoin. 

You recognize $300 of ordinary income. 

In some cases, your staking rewards may be ‘locked up’ and you may not be able to withdraw them. In cases like these, it’s likely that you won’t recognize income until you are able to withdraw your rewards. 

Tokens that increase in value: Capital Gains 

In some cases, your ‘rewards’ may take the form of your existing cryptocurrency increasing in value. It’s likely that these tokens will be subject to capital gains tax upon disposal. 

Example:

You deposit $5,000 of USDC in Compound. 

You receive cUSDC that represents your share of the USDC supply. 

One year later, your share grows to $5,200. 

You withdraw your share, trade back your cUSDC, and incur a capital gain of $200. 

Is sending crypto to another wallet taxable? 

Transferring crypto to another wallet that you own is not considered a taxable event. 

However, spending cryptocurrency to pay for blockchain transfer fees is considered a taxable disposal subject to capital gains tax. 

For more information, check out our guide to the tax implications of moving crypto between wallets. 

How are governance tokens taxed? 

Governance tokens are often used to reward DeFi investors for using a protocol. Receiving and disposing of these governance tokens comes with tax implications. 

Receiving governance tokens: Income tax 

You recognize ordinary income when you receive governance and incentive tokens. The amount of income you recognize is equal to the market value of  the governance token at the time it is received. 

Selling governance tokens: Capital gains tax 

When you sell your governance token, you trigger a taxable event and recognize a capital gain or capital loss depending on how your crypto has changed in value since you originally received it.

Example: 

You receive $500 of COMP. 

Later, you sell your COMP for $600. 

You recognize $500 of ordinary income and $100 of capital gain.

How are DeFi loans taxed? 

Often, crypto protocols allow users to take out loans after depositing crypto as collateral. Let’s explore the tax implications of taking out a DeFi crypto loan. 

Taking out a loan: Potentially subject to capital gains tax 

Generally, taking out a loan is not considered a taxable event. Therefore, it’s reasonable to assume that crypto loans will be treated the same way. 

However, some DeFi loan providers require executing a swap in order to take out the loan. For example, taking out a loan on Ethereum in Compound requires you to exchange ETH for cETH. It’s unclear whether this will be considered a taxable event like other crypto-to-crypto transactions. 

The conservative approach would be to report this type of loan as a taxable event and incur capital gains or losses depending on how the price of your collateral has changed since you originally received it. 

The aggressive approach would be to consider the deposit of collateral as a transaction that does not transfer tax ownership to the custodian. This would be treated as non-taxable. 

Forced liquidations: Capital gains tax

Some platforms automatically liquidate your collateral if you do not meet the platform’s loan-to-value ratio. This is considered a disposal subject to capital gains tax, which you will be required to pay regardless of whether you receive the proceeds of the sale. 

Crypto Loans Interest Payments: Deductible in some situations 

The IRS has yet to issue specific guidance about the tax implications of interest payments in crypto lending. However, you can get a better idea for how they may be treated by looking at traditional lending. 

To understand whether your interest payments are tax-deductible, it is necessary to consider whether a loan is used for personal, investment, or business-related purposes.

If a business takes out a loan for a commercial purpose, the interest is treated as a legitimate tax-deductible business expense.

If a loan is taken out for personal reasons, interest expense is typically not considered tax-deductible. Your loan will fall into this category if you’re taking out the loan to pay off credit cards, or even to pay your tax bill.

If you use the borrowed funds for investment purposes (for example, yield farming or purchasing/trading coins) the interest expense you incur is classified as investment interest expense. Investment interest expenses are subject to special tax rules and are deductible only up to your net investment income. 

‍For more information, check out our complete guide to how cryptocurrency loans are taxed. 

How are wrapped tokens taxed? 

Some investors ‘wrap’ their existing coins to interact with DeFi protocols. For example, investors may wrap their Bitcoin to interact with protocols built on the Ethereum blockchain. 

Since the IRS has not yet ruled on the issue of wrapped tokens, it is considered a gray area in the tax code. As a result, some investors choose a conservative approach to reporting these transactions, while others choose a more aggressive approach. 

Conservative approach: Treat the act of wrapping your coins as a crypto-to-crypto exchange. You’ll incur capital gains or losses depending on how the price of your tokens has changed since you originally received them. 

Example: 

You have BTC worth $1,000. 

The price of BTC rises to $1,800. 

You ‘wrap’ your Bitcoin and receive WBTC. 

You incur $800 of capital gain. 

Aggressive approach: Treat the act of wrapping your coins as equivalent to holding the same cryptocurrency. In this case, wrapping would be considered a non-taxable event. 

For more information, check out our complete guide to how wrapped/bridged tokens are taxed. 

How are bridged tokens taxed?

Bridging allows investors to move assets from one blockchain to another. 

It’s likely that bridging will not be considered a taxable event. Unlike wrapping, there isn’t necessarily an event where one cryptocurrency is directly swapped for another. As a result, a taxable disposal likely does not occur. 

However, some investors choose to take the ultra-conservative approach of treating bridging tokens as a taxable event subject to capital gains tax. 

How are Layer 2 DeFi solutions taxed? 

Many investors use Layer 2 solutions like Polygon and Arbitrum for DeFi because they offer lower fees and faster transaction times. 

For the most part, Layer 2 DeFi transactions are taxed just the same as other DeFi transactions. However, you may incur taxes for wrapping and bridging your cryptocurrency from Layer 1 to Layer 2. For more information, take a look at the sections above. 

How are DeFi airdrops taxed? 

Often, DeFi projects will airdrop tokens to early users. 

If you receive an airdrop, your rewards will be considered ordinary income based on the fair market value of your crypto at the time of receipt. If you dispose of your airdrop rewards in the future, you’ll incur a capital gain or loss depending on how the price of your crypto has changed since you originally received it.

Example: 

Angela receives a UNI airdrop worth $400. 

Later, she sells her airdrop rewards for $500. 

Angela realizes $400 of income and $100 of capital gain. 

How is margin trading and DeFi derivatives taxed? 

Some DeFi protocols offer margin trading and derivatives. 

At this time, the IRS has not released guidance on how these types of transactions are taxed. However, it’s likely that profits from margin trading and derivatives will be taxed as capital gains. 

Can I be audited for DeFi?

While getting audited for DeFi activity is relatively rare, it has become increasingly more common in recent years. It’s likely that due to increased funding, the IRS will only become more aggressive in auditing investors in the future. 

Accurately reporting your DeFi transactions can help minimize your odds of being chosen for an audit. This means you should report transactions from all the wallets you are using and keep a comprehensive record of your transaction history (more on this below). 

If you are selected for an audit, it’s a good idea to reach out to a crypto tax professional who can help you guide you through the audit process. 

What records should I keep for DeFi taxes? 

To accurately report your DeFi taxes, you should keep records of the following information. 

• The type of cryptocurrency involved in the transaction
• How many units of cryptocurrency involved in cryptocurrency 
• The date you received the cryptocurrency 
• The date you disposed of the cryptocurrency 
• The fair market value of the cryptocurrency at receipt
• The fair market value of your cryptocurrency at disposal 

If you’ve transferred your crypto between different wallets and exchanges, you may have trouble collecting this information. In this case, crypto tax software like CoinLedger can help. 

How do I report my DeFi taxes? 

Once you’ve collected the information you need to report your DeFi taxes, you should report each taxable transaction on your taxes. 

Transactions subject to capital gains tax should be reported on Form 8949. Transactions subject to income tax should be reported on Schedule 1 for individual investors. 

For more information, check out our guide to reporting your crypto taxes. 

How do I report DeFi losses on my taxes? 

Capital losses from DeFi can be used to offset capital gains and potentially reduce your tax bill. If you have a net loss for the year, you can roll forward your loss to future tax years. 

Capital losses can be reported alongside capital gains on Form 8949.

DeFi platforms - tax treatment overview

Below we have summarized the high-level tax implications relating to specific DeFi protocols. Keep in mind, the IRS has not passed any specific DeFi tax guidance to date. Please keep in mind the below descriptions represent the conservative tax approach inferred from current IRS crypto guidelines.

Uniswap V2

Uniswap is a decentralized exchange that allows users to trade/swap between cryptocurrencies as well as contribute crypto to liquidity pools to earn income.

• Trading one cryptocurrency for another on Uniswap is a taxable event and triggers capital gains or losses based on how the price of the coins you are trading away have changed since you originally received them. 
• When you contribute to a liquidity pool, you receive liquidity pool tokens representing your share of the pool. This triggers a taxable event and capital gains/losses apply. In other words, when you enter a liquidity pool, you are effectively trading your underlying cryptocurrency for the Uniswap liquidity pool token. 
• UNI liquidity pool tokens increase in value as the pool accrues interest. When you divest from the liquidity pool, you exchange back the UNI liquidity pool tokens and realize any capital gains or losses. 
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Uniswap V3

Instead of LP tokens, Uniswap V3 gives liquidity providers NFTs that represent their position in the liquidity pool. 

• Wrapping a liquidity position into an NFT is a taxable event. You’ll recognize gains or losses depending on how the price of the tokens you wrapped changed since you originally received them. 
• The value of your NFT will increase as the pool accrues interest. When you divest from the liquidity pool and swap your NFT for your underlying position, you’ll recognize capital gains/losses depending on how the value of your NFT has changed. 
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Compound

Compound is a decentralized protocol that enables borrowing, lending, and  earning interest.

• Exchanging tokens like ETH for cETH is a taxable trade subject to capital gains tax (you dispose of your ETH when exchanging it for cETH).
• Your cTokens increase in value as you lend. You incur capital gains when you convert your cTokens back for the underlying asset.
• Any COMP earned as a reward is taxable income based on the fair market value of COMP at the time of earning. .
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Aave

Aave is a DeFi protocol that allows users to provide liquidity, earn interest, and borrow funds.

• You incur capital gains/losses on the crypto asset you exchange away when minting aTokens based on how its price has changed since you originally received it. 
• Interest received from lending accrues to you in the form of additional aTokens. Each time you receive aTokens, you have income equal to the fair market value of those tokens at the time of receipt.
• Similar to providing liquidity on other platforms, users can stake AAVE in return for STK AAVE tokens, which triggers capital gains upon entry and exit.
• Holding STK AAVE also generates AAVE token rewards. This is taxed as ordinary income at the fair market value at the time of receipt.
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Maker

Maker — and the platform’s decentralized exchange Oasis — allows users to trade between assets, borrow against collateral, and earn DAI either by locking ETH or other cryptocurrencies as collateral or via DAI savings.

• Trading one cryptocurrency for another on Maker is a taxable event and triggers associated capital gains or losses just like trades on centralized exchanges. 
• Earned DAI is subject to income taxes at the fair market value of DAI at the time of receipt.
• Using cryptocurrency as collateral on Maker does not trigger a taxable event. If the position is liquidated, a taxable event is triggered and the underlying assets will incur capital gains/losses based on the value of the assets upon liquidation.
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Balancer

Similar to Uniswap, Balancer allows you to trade or swap cryptocurrencies as well as contribute to liquidity pools. 

• Trading one cryptocurrency for another on Balancer is a taxable event and triggers capital gains or losses, just like trades on centralized exchanges.
• Entering or exiting a Balancer liquidity pool is a taxable event that incurs capital gains or losses.
• Balancer Pool Tokens also generate income in the form of BAL tokens which are periodically distributed to liquidity providers. Each time you receive BAL tokens you have ordinary income equal to the fair market value of those tokens at the time of receipt. 
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OlympusDAO

OlympusDAO is the protocol behind the OHM token, a unique stablecoin where value is derived from the platform’s treasury as well as market demand. This is in contrast to typical stablecoins, where value is pegged to the price of fiat currencies. The token uses rebasing to reward OHM stakers. 

Because the mechanisms behind rebasing are so complex, we recommend checking out our blog post on how protocols like OlympusDAO are taxed. 

Report your DeFi taxes with CoinLedger 

Trying to report your DeFi taxes can be stressful. Luckily, CoinLedger can help you file your taxes in minutes. 

All you have to do is connect your Ethereum wallet with CoinLedger. Then, the platform will pull in your complete transaction history — including trades on protocols like Uniswap. 

CoinLedger makes the tax reporting process easy, even if you’re not a tech or finance expert. That’s why more than 500,000 investors around the world use the platform to handle their tax reporting.  

‍Get started with a free preview report today — there’s no need to enter your credit card details until you’re 100% sure your information is accurate!