Crypto Liquidity Pool, Yield Farming and US Taxes Guide

by CrabCommander

Staking (on your own or in pools which do not give some kind of Staking Pool Token)

• For these, you’re considered the owner of the asset during the entire duration, (You did not perform a ‘trade’, and the staking pool manager is only holding the assets custodially, similar to an exchange)
• As such, you pay ordinary Income Taxes on the additional [COIN] you gained from staking, at price-basis of the time at which you gained them.
• Any asset appreciation or loss on the original [COIN] is not taxed until such a time as you sell/trade your original [COIN], at which point you pay Capital Gains taxes as per normal.
• Any asset appreciation on the staking rewards is taxed as normal Capital Gains, with their Long-Term Capital Gains timer starting from the point at which you were given them.
• Staking the asset in this manner does not interfere with Long Term Capital Gains – Ex. If you hold the asset for more than a year, you may stake/unstake it as many times as you like and still claim Long Term Capital Gains.

Liquidity Providing

• For DeFi Liquidity Pools, the initial action of sending the assets into the LP is considered a ‘Trade’ for LP Tokens, and thus a taxable event. As such, this also interrupts/resets the timer on Long Term Capital Gains.
• Accrual of additional assets from the LP is treated as either standard Income Tax at cost basis of the time you obtain it (in the event you are given ‘more’ assets as the manner of distribution, Ex. AAVE). Or as Capital Gains (in the event that the pool yield is only obtained when you ‘sell’ your LP tokens, Ex. Compound).
• Any gains on your initial [COIN] itself (the LP tokens in this case) are treated as Capital Gains, at price basis on when you exit the LP, as this is again considered a ‘Trade’. If you were in the LP for more than a year continuously, you may claim Long Term Capital gains on these.
• Any further gains after exiting the LP are treated as capital gains, as per normal, with the Long Term Capital Gains timer starting from the point at which you exited the LP pool.

Tax Efficient Choices

So, given this information, it seems like the most tax efficient choices are..

• Stake Assets which are already in Long Term Capital Gains mode/you’ve already had for some time, so you don’t end up falling back to the basic Capital Gains rates.

or

• Participate in a Liquidity Pool which only pays out when you cash out the LP tokens, and stay in for a year+ for the Long Term Capital Gains reduction on both your asset appreciation and LP payments.