Are you considering yield farming in DeFi but have no idea about the potential tax implications of these transactions? Billions have flown lately into yield farming protocols across multiple chains, generating profit for many crypto investors. Yield farming can be a lucrative venture, but not handling the associated taxes properly can easily lead to losses. In this regularly-updated guide written by tax experts, we break down the latest guidance on yield farming taxes. Understand the tax implications of how yield farming is taxed and learn essential tips on how to minimize your crypto taxes with Accointing.

Yield Farming Taxes: The Complete Guide 2023 - Accointing by Glassnode

Yield farming is a DeFi investment activity that involves delegating digital assets into a liquidity pool via smart contracts in exchange for extra tokens. Yield farmers lock up their crypto funds in a decentralized application (dApp) to receive tokens in return. Users can choose to receive the rewards in their wallets or reinvest it back into the liquidity pool. The catch in these protocols is the attractive annual percentage yields (APYs) offered.

Although we have no clear tax guidance on yield farming transactions, they aren't exempt from taxation. Yield farming is taxable in the US. Keep in mind that yield farming includes numerous transactions that can be classified according to existing crypto tax rules.

In short, any income derived from farming activities is subject to ordinary income tax. If you're trading or selling crypto received from yield farming, that would fall under capital gains tax.

•  Earning interest or rewards paid out in a token for locking your money within a dApp is subject to the ordinary income tax at the Fair Market Value (FMV) at the moment the tokens were received.

•  Selling tokens received through yield farming falls under the scope of capital gains tax, regardless of whether you make a profit or loss, you must record the sale on your taxes whether you sell the tokens for fiat money or other cryptocurrencies.

•  Certain yield farming activities can be regarded as crypto disposals and be subject to capital gains tax. For example: exchanging your assets for LP tokens, could result in a capital gain or loss depending on the price change of the digital assets acquired. Therefore, the value fluctuation of your LP tokens, including the value of the cryptocurrency you got as a reward, may result in a capital gain if you redeem them for another asset.

Types of Taxes Associated with Yield Farming

When it comes to yield farming, the tax implications can vary depending on the specific details of your transactions. In summary, yield farming activities may be subject to income tax, while others may be subject to capital gains tax. To prevent any potential tax-related concerns, it is essential to stay up to date on the most recent tax laws and appropriately classify your transactions.

Every time you buy, sell, or use your crypto assets, you'll be subject to capital gains taxes (CGT). This is because crypto is classified as property for tax purposes. In order to calculate your taxable gain or loss simply subtract the cost basis (i.e. acquisition cost plus any transaction fees), which is the amount you receive for your cryptocurrency in USD.

The IRS considers virtual currency as taxable property for federal income tax purposes. The agency issued Notice 2014-2, along with FAQs, to clarify that gains and losses on the disposition of crypto assets are subject to capital gains taxes.

Crypto income in any form, including yield farming rewards, is subject to income taxes and must be reported on your income tax return. If you receive more coins or tokens in your wallet or exchange account compared to what you had before, the new tokens received should be taxed as ordinary income based on their value at the time of receipt.

The IRS issued the Notice 2014-21 and the Rev. Rul. 2019-24 in order to provide guidance on airdrops, hard forks, and mining. In both cases, the IRS concluded that new units of cryptocurrency received by the taxpayer are considered income for tax purposes. Although there is no formal tax guidance on yield farming income, it is generally treated the same as mining income.

Special Tax Rules for Comp Tokens and LP Tokens

Liquidity pools are contracts used in decentralized exchanges that allow users to pool funds and earn a portion of generated trading fees in exchange for providing assets via Liquidity Pool tokens.

•  Swapping crypto tokens or coins for LP tokens is a taxable event that falls under CGT. Like with any other type of token swap, the profit or loss is based on the difference in value.

•  Any rewards received are taxed when you have control over them under the income tax.

•  Trading LP tokens back for original coins or tokens are also a taxable event under CGT based on the tax basis of LP tokens compared to the value of the coins or tokens received (this is taxable due to the impermanent loss risk - which means you don't have control over original coins).

If you receive income from yield farming it's taxed under the income tax at the FMW when the tokens were received. Compounding rewards is essentially the same as if you had taken the coins and staked them yourself to earn more yield. This means that you will keep getting more income. It's a similar concept to owning a stock and reinvesting the dividend back into the stock. The only difference is that the dividend is taxed as ordinary income while increasing your position is a nontaxable event. However, it becomes tax relevant once you sell the stock or token in this specific case.

Strategies to Minimize Your Tax Burden from Yield Farming

Accurately record every transaction you make to be able to determine your tax obligations. This includes tracking the initial cost basis of any crypto asset, the value of any rewards received, and any fees paid. Use a crypto tax software like Accointing to simplify the tax reporting process.

Track your crypto portfolio with Accointing for FREE.

If you hold your assets for more than a year, you may qualify for long-term capital gains tax rates, which are typically lower than short-term rates. Always consult with your tax advisor.

If you have losses from yield farming, you can use them to offset any gains you have realized during the tax year. This can help reduce your tax liability if done properly, to do so use the trading tax optimizer (TTO) to save hundreds and even thousands of dollars in taxes.

Use Decentralized Exchanges and Centralized Exchanges Appropriately

If you're a user on both centralized finance (CeFi) and DeFi platforms, you should keep track of all your transactions across all addresses to benefit from tax optimization advantages. Some examples include identifying internal transactions between same wallets, which are tax-free transactions, or offsetting losses to reduce your capital gains.

Keeping track of your crypto transactions is crucial for reporting your taxes accurately. This includes important details such as the cryptocurrency's description, acquisition date, disposal date, proceeds, cost basis, and gains or losses.

Understand the Difference between Long-term and Short-term Gains

Depending on whether capital gains are long-term or short-term, taxpayers in the US are liable to various tax rates. In order to encourage investors to stay in their investments for longer periods of time, long-term gains are taxed at a reduced rate, whereas active traders are subject to higher conventional tax rates.

Pivot on the taxpayer's usual tax rate, long-term gains from cryptocurrencies held for more than a year will be taxed at rates of 0%, 15%, or 20%. The marginal tax rate of the taxpayer, which can range from 10% to 37%, will be applied to short-term gains from cryptocurrencies held for a year or less. If you run into any questions regarding capital gains or crypto taxes FAQs, check out the Crypto Tax Guide 2023.

Calculating the cost basis for yield farming transactions is a crucial part of complying with US tax laws. The cost basis essentially represents the acquisition cost of your crypto, including any fees, which is necessary for calculating capital gains or losses when the asset is sold or traded.

For yield farming transactions, determining the cost basis can be more complex due to the variety of tokens involved, the duration of the yield farming period, and any rewards earned during that period. To simplify the process, it's recommended to use a first-in, first-out (FIFO) or weighted-average cost basis method.

Let's assume Bob invested $10,000 worth of ETH in a liquidity pool. During the yield farming period, the farmer earned rewards in the form of UNI and DAI tokens. Over time, the farmer earned 100 UNI tokens worth $500, and 100 DAI tokens worth $100.

Using the FIFO cost basis method, the first 100 UNI and 100 DAI tokens earned would be considered to be sold or disposed of first when the farmer chooses to liquidate their investment. The cost basis for those tokens would be the value of the original investment at the time they were earned, which was $10,000.

If the farmer decides to sell all of their UNI and DAI tokens when they are worth $700, their capital gains would be $200 ($700 - $500). The cost basis for the UNI and DAI tokens would be $10,000, resulting in a net gain of $1900 ($700 - $200 capital gains - $10,000 cost basis).

It's important to keep track of all transactions and rewards earned during a yield farming period to accurately calculate the cost basis and report any capital gains or losses on tax returns.

The tax rules for yield farming can be complex, so it's important to consult a tax advisor for advice and to fully understand your tax obligations and identify strategies for minimizing your tax burden.

Accointing's crypto tax platform can help with reporting your yield farming taxes. The tool provides a complete overview of your transactions, automatically calculates your tax liability, and generates an accurate tax report based on your data from connected wallets and exchanges.

Currently, there are no specific tax rules for yield farming. However, any new cryptocurrency received as a reward from yield farming is considered income and must be reported for income tax purposes. If you sell the reward asset for a profit or swap it for another cryptocurrency, it will be subject to capital gains tax as a crypto-to-crypto trade. It's important to stay informed about tax regulations and consult with a tax advisor for guidance.

High potential returns on investment (APYs)

Provides liquidity to decentralized finance protocols

Can serve as a hedge against inflation if done properly and with a solid strategy

Offers a chance to participate in emerging blockchain projects

High risk of impermanent loss, that’s basically when the profit earned is less than what you would have earned by just holding the assets separately.

Requires some advanced knowledge regarding DeFi

Vulnerable to market volatility and smart contract risks (exploits, rug pulls, and many more)

Users may incur high gas fees and transaction costs

How can Accointing Help with Reporting Yield Farming Taxes

Accointing is a cryptocurrency tax software that simplifies the tax reporting process for yield farmers. The crypto tax software is designed to automatically import data from various exchanges and wallets, making it easy to calculate your tax liability accurately.

To report yield farming taxes with Accointing, you need to go through four easy steps:

Step 1: Import your cryptocurrency transactions by connecting all your wallets and exchanges.

Step 2: Classify your transactions. The tool will automatically calculate your cost basis, profit or loss, and rewards.

Step 3: Calculate your tax liabilities by simply following the review steps: "Unknown currencies," "Identify internals," "Classify transfers," and "Missing funds". These are crucial for ensuring that your cryptocurrency portfolio is accurately tracked and organized on the platform.

Step 4: Generate a tax report and file it with your preferred tax filing software. For more details, check out our Tax Filing Guide for 2023. 

•  Yield farming transactions fall either under capital gains tax or income tax, depending on the nature of the crypto transaction and your investment strategy. The regulatory landscape is still evolving, so keeping up with the latest guidance is important to stay compliant.

•  Yield farmers should carefully study the relevant tax laws and regulations to maximize their returns while staying on the right side of the law. Check out our complete US Crypto Tax Guide for 2023 for more details. 

•  Using a crypto tax tool like Accointing for calculating your taxes can simplify the process of getting a tax report, especially if you are dealing with complex DeFi transactions. You only need to connect all your wallets containing the yield farming transactions. From here, the tool will automatically calculate any gain, loss, income and internal transactions.

Yield Farming Taxes: The Complete Guide 2023

The Internal Revenue Service (IRS) has increasingly shown interest in crypto tax compliance. With the frequent regulatory changes, staying up-to-date on the latest tax guidance is more important than ever. In this regularly-updated expert guide, we’ll explain everything about the tax implications of different DeFi activities and how to report DeFi transactions on your tax return.

The Expert Guide to DeFi Taxes [2023] - Accointing

Remember when you thought crypto was tax-free? Yeah, neither do the tax authorities. As DeFi continues to grow, crypto investors should know that the gains from decentralized finance activities may come with a tax bill. 

The Internal Revenue Service (IRS) has increasingly shown interest in crypto tax compliance. With the frequent regulatory changes, staying up-to-date on the latest tax guidance is more important than ever. In this regularly-updated expert guide, we’ll explain everything about the tax implications of different DeFi activities and how to report DeFi transactions on your tax return. 

As of March 2023, according to data retrieved from Defillama, the total value locked (TVL) across multiple decentralized applications (DApps) and chains, home to dozens of DeFi protocols, is around USD 49 billion!

DeFi has continued to attract investors thanks to the promising potential for disrupting the traditional financial system by being borderless, transparent, and limitless. DeFi protocols eliminate the need for an intermediary, like a bank, to manage financial processes. Such autonomous operation is possible thanks to smart contracts, or automated protocols that run on a blockchain.

Interacting with DeFi protocols is subject to taxation in the US. The complexity involved in DeFi transactions has created some gray areas in tax treatment. The IRS has not released DeFi-specific guidance, but the following basic tax rules apply for DeFi transactions. 

The IRS classifies profits from selling a held item as capital gains, whereas cryptocurrency received directly is categorized as income. According to the IRS, the type of taxation depends on the "nature of the transaction" and whether it’s capital- or revenue-based. 

Capital Gains Tax (CGT) applies when you're spending, swapping, or trading crypto. A capital gain is an increase in the value of a capital asset. Capital gains are returns earned when you sell an investment for more than the purchase price. 

Meanwhile, income tax applies to any activity seen as income for tax purposes. Investment income is profit from interest, dividends, and other profits obtained via an investment vehicle. 

When it comes to DeFi activities, some transactions are classified as capital gains from trading appreciated crypto, while others may be classified as income on tokens received for staking or minting crypto. 

Decentralized exchanges (DEXs)  allow users to buy, sell or trade crypto tokens without the need to go through a centralized platform. DEXs use automated market makers (AMMs) to enable trading. Users transfer the tokens they want to exchange to the smart contract of an AMM. The contract then calculates the exchange rate based on the supply and demand of the tokens, determines the amount of the other token the user will receive, and returns it to the user.

A swap happens every time you exchange one digital asset for another. According to the IRS, this triggers a taxable event because it involves the exchange of one digital asset for another (crypto-to-crypto trade). 

Buying crypto in exchange for any other cryptocurrency (including stablecoins) constitutes a trade, and Capital Gains Tax (CGT) applies in this case. CGT is not applied anytime you use fiat money (USD) to purchase crypto.

If you record a loss, you won't have to pay any taxes. However, keep note of your losses so you can use them as an offset against profits to reduce your tax bill.

Staking refers to the process of locking assets up in a smart contract to serve as a validator while earning tokens as a reward for the temporary commitment of your assets. Staking nodes perform important functions such as verifying and broadcasting transactions, storing a copy of the blockchain, and executing smart contracts. Each node earns rewards for its work of validating transactions. 

Many blockchain-based protocols and networks offer staking services, such as Ethereum, Cardano, and Cosmos. Each protocol and network has unique staking mechanisms, reward structures, and requirements for participation. Additionally, some Layer 2 (L2) scaling solutions like Polygon and Optimism also offer staking services. 

The IRS has not provided much guidance on the taxation of nodes and staking. However, industry practice based on other IRS guidance from similar income types of events indicates that staking income is subject to income tax based on its fair market value at the time of receipt. 

Any node rewards are also subject to income tax, similar to other coins received from staking. Swapping earned tokens is subject to capital gains tax based on the value obtained from them relative to their tax basis (purchase price). 

New DeFi projects and protocols frequently use airdrops to incentivize early supporters, gain new users, and receive media attention. To obtain the 'airdropped' tokens, users must meet specific requirements like holding a particular cryptocurrency or using a specific dApp. 

Airdrops are taxed as regular income based on the asset's market value when it is received. According to Rev. Rul. 2019-24, if the taxpayer gets new cryptocurrency units, the acquired assets are taxable. 

Any trade or swap of the received assets is subject to CGT, applied on any value increase from when you received the tokens to when you swapped them. Swapping airdropped tokens for another cryptocurrency is also subject to capital gains tax. 

Using a crypto tax tool like Accointing, you can effectively keep track of all your airdrops and filter out scammy ones, ensuring you're not paying double tax on airdrops.

Liquidity pools are smart contracts often used in DEXs and AMMs that allow users to pool their funds to provide liquidity for trades. By adding assets to a liquidity pool, users earn a portion of the generated trading fees based on their allocation. In exchange for the added funds, users receive LP tokens representing their share of the pool, which can be redeemed for the underlying assets at any time. Popular examples of protocols with liquidity pools include Uniswap, Curve, Balancer, and SushiSwap.

While the IRS hasn't given any specific rules to handle taxes on LP transactions yet, here is an educated guess based on each trade. 

When you swap your coins, tokens, or pairs for a liquidity pool token (LP token), this is considered a taxable event because you are trading one digital asset for another. Your profit or loss will be determined by the difference in value between the coins/tokens you gave up and the LP tokens you received. The original cost of your tokens becomes your tax basis, and the value of the LP tokens you received will be considered your earnings.

Any rewards you get from your LP token investment will be taxed when you have control over them, just like with other types of income like mining or staking. 

Trading your LP tokens back for the original coins/tokens also makes a taxable event. You'll have to report your profit or loss based on the tax basis of your LP tokens compared to the value of the coins/tokens you got back in the trade.

Some may argue that this is just like making a deposit, where you expect to get your original coins back. However, the fact that impermanent losses happen in liquidity pools means that you don't have control over your original coins, which makes a strong case for these transactions being taxable.

Uniswap is a decentralized exchange (DEX) that enables users to trade cryptocurrencies, create liquidity pool positions, and trade NFTs. Uniswap V2 improved upon the original protocol by supporting ERC-20 token pairs and implementing a constant product market maker algorithm, which keeps the price of each token balanced based on demand.

Uniswap V3, the latest protocol upgrade, introduced concentrated liquidity. This allows liquidity providers to indicate a price range for transferring their funds, reducing slippage and enabling more efficient capital use. The different versions of Uniswap offer specific features and benefits to users, and the version you use will depend on your trading needs and preferences.

Is Switching from Uniswap V2 vs. V3 Taxable?

Typically, switching from Uniswap version 2 to version 3 wouldn't be a taxable event since you’re still holding the same assets. The only thing is that V3 has more features, such as fee structuring while creating an LP or setting up price ranges for creating a liquidity position. Allocating liquidity between a certain price range could be seen as a taxable event by the IRS and is subject to capital gains tax.

To find out more about this, check out Accointing’s updated Crypto Tax Guide. 

Decentralized protocols let people lend and borrow cryptocurrency using liquidity pools. Lenders put in their crypto, and borrowers can use their crypto as collateral to get a loan. The interest rates are determined by supply and demand, and lenders make money from the interest. Popular DeFi protocols that offer this service include Aave, Compound, and MakerDAO. People like these protocols because of their ease of use, interest rates, transparency, and security. 

When you lend crypto, you're putting an asset into a lending pool, which doesn't trigger a taxable event. However, if you receive a token that represents your share of the lending pool it may trigger a taxable event because it's viewed as swapping crypto for another crypto, which would be subject to CGT. On the other hand, earning interest on supplied assets can also have tax implications, for example, rewards received in the form of tokens for lending out capital are subject to the ordinary income tax, and if these are traded for other cryptocurrencies, you are incurring in a GGT.

In DeFi, people can get a loan without a middleman by using collateral. They put their assets in a pool and use smart contracts to borrow money. The collateral secures the loan, but it's usually worth more than the loan to reduce risk. If the collateral's value drops, the lender can sell it to get their money back. You can use DeFi borrowing on different blockchains, like Ethereum and Binance Smart Chain, and popular protocols include  Aave, Compound, and Oasis. To summarize, people put up collateral, get a loan, pay interest, and repay the loan in DeFi borrowing.

If you borrow cryptocurrency, you won't have to pay taxes on it as income. Keep in mind that using cryptocurrency to pay off a loan is not considered a business expense and cannot be deducted.  When a position gets liquidated, the resulting loss can be offset against other capital gains. 

Receiving tokens as an incentive for borrowing funds or from assets earned from the borrowed funds can have tax implications. The value of the tokens received (at FMV) is generally considered income and must be reported on the borrower's tax return as income. Nevertheless, if you sell or exchange them later, you may owe capital gains tax on the difference between the value of the tokens when received and sold. It's important to consult with a qualified tax professional to ensure that you are properly reporting any income or capital gains resulting from borrowing activities.

Yield farming is an optimized way to earn more tokens by lending or staking your tokens on a DeFi platform. Users deposit their crypto assets into a smart contract-based liquidity pool and the rewards are paid out based on how much liquidity is provided (smart contracts make it possible to supply liquidity to different token pairs for high APYs). However, there are risks like impermanent loss and price slippage during volatile markets while dealing with yield farming protocols. For withdrawal of funds, users must return their tokens to the pool and get a share of the pool's assets. Some popular protocols include Beefy Finance and Convex.

Tax regulations for yield farming have not been established as of yet. It is important to know that income (receiving a new cryptocurrency as a reward) derived from yield farming will be subjected to income tax. Additionally, if you make any profit from this activity, you must report it for the purposes of paying capital gains tax. On the other hand, selling the reward asset for more of the staked position for achieving high APYs or just swapping it for another cryptocurrency is subject to the CGT as being a crypto-to-crypto trade. 

Bridges are connectors that allow different blockchain networks to interact with each other in DeFi. They work by locking or freezing digital assets on one blockchain (origin chain) and creating an equivalent amount of assets on another blockchain (destination chain). The flow of funds involves sending assets to the bridge contract, which then mints new assets on the destination blockchain. 

When the user wants to redeem their original assets, they send the bridged assets back to the bridge contract, which then burns them and unlocks the original assets for the user. However, bridges are subject to risks such as bugs or vulnerabilities in the smart contract code, and attacks or exploits from malicious actors. 

Popular bridges include Hop protocol, as well as other bridges that connect Ethereum to other blockchains like Polkadot, Cosmos, Optimism, Arbitrum, and Avalanche. Bridges play an important role in expanding the range of possibilities in DeFi, but users should take appropriate precautions to protect their assets.

How is bridging tokens over to a different blockchain taxed?

Taxation on activities related to bridges in DeFi is a complex topic. Some jurisdictions may consider it a taxable event to move an asset from one chain to another. Even though you’re still holding the same asset, the smart contract is different, and, therefore, this constitutes a crypto-to-crypto trade. Yet, in other cases, it may be seen as a non-taxable self-transfer since you’re still holding the same asset in terms of pricing. 

When a token is wrapped and goes cross-chain, this is considered a taxable event. It's important to seek advice from a cryptocurrency tax specialist to ensure compliance with tax laws when bridging assets in DeFi. Additionally, using crypto tax software such as Accointing can help you keep track of DeFi transactions, especially bridges, and ensure accurate reporting to avoid potential tax issues.

Decentralized Autonomous Organizations (DAOs) operate without a central authority. They're digital organizations that use smart contracts and are managed democratically by their members. They use governance tokens that give holders the right to vote on proposals and changes to the protocol. Members can earn rewards for participating in the governance process, adding liquidity, or completing other project-related tasks. Some well-known DAOs are Maker DAO and Decred.

You must declare any asset received from any activity performed in a DAO as income on your tax return (if you obtain it from a DAO in exchange for any products or services you rendered). Also, if you get governance tokens or NFTs in the form of distribution, these must be reported as income in your tax bill. You will be liable for cryptocurrency capital gains tax if you sell these assets in the future.

Synthetic assets are digital tokens that in essence are blockchain-based derivatives. These tokens are created through smart contracts and derive their value from price feeds or oracles. Users deposit collateral to purchase synthetic assets. They can represent the value of various assets such as stocks, cryptocurrencies, and more. 

Popular protocols that offer synthetic assets are Synthetix and UMA. When a user wants to redeem the synthetic asset, they return it to the smart contract and receive back their collateral.

Because synthetic assets are not backed by an underlying asset, they are considered derivatives. Generally, the IRS treats derivatives as property for tax purposes. This implies that transactions involving synthetic assets may be subject to capital gains tax.

For instance, if someone purchases a synthetic asset and sells it for a profit, they might be required to pay capital gains tax on the profit. The particulars of each transaction may have an impact on how taxes are treated. Therefore, it is preferable to obtain the guidance of an experienced tax practitioner.  

Options trading and margin trading are two methods that users can use to potentially profit from buying or selling assets. In options trading, users can buy or sell assets at a specific price and time. In margin trading, users can borrow funds to buy or sell assets. Smart contracts are used to determine the trading or borrowing limit based on the collateral that users deposit. Profit can be made if the market moves in the user's favor, but there is a risk of loss and liquidation if the market moves against them. Services for options trading and margin trading are available on different chains like Ethereum, Binance Smart Chain, and Solana and are provided by protocols such as Open Leverage and dYdX. In summary, margin trades carried out in the spot market typically entail borrowing funds to enhance the capital available for trading. 

Regarding taxes, gains and losses from cryptocurrency options and margin trades are required to be reported as capital gains tax unless it's a regulated contract on a regulated exchange - take into consideration that nothing on DeFi will be. In summary, any gains from margin trading in DeFi are subject to capital gains tax. On the other hand, options trading in DeFi is generally treated as a capital gain or loss when the option is exercised or expires. It's important to keep track of all your trades and transactions, including those in margin trading and options protocols, and report them accurately on your tax return to avoid potential penalties or legal issues. 

Futures and derivatives are financial tools that allow users to speculate on the future price of an asset, such as Bitcoin or Ethereum and are traded on DeFi through smart contracts. Users deposit collateral, and the smart contract creates a trading position based on the underlying asset's value. As the asset's price changes, the trading position's value changes, resulting in profits or losses. Futures are contracts that track the price of an underlying asset. Traders can allocate funds towards a movement down (short) or up (long). On the other hand, derivatives derive their value from an underlying asset's price. Popular DeFi protocols that offer futures and derivatives trading include Zeta Markets and Hegic, available on different chains like Ethereum, Arbitrum, and Solana.

Regarding taxes, gains and losses from cryptocurrency transactions related to futures and derivates fall under the scope of the capital gains tax unless it's a regulated futures contract on a regulated exchange - take into consideration that nothing on DeFi will be. In order to be a regulated contract it must be traded on an approved board or exchange and require margin account adjustments depending on daily market conditions. The Chicago Mercantile Exchange (CME) presently recognizes Bitcoin futures and options as 1256 contracts, which are governed by unique tax laws. Other cryptocurrency derivatives' tax treatment will depend on whether or not they qualify as Section 1256 contracts. Futures contracts are subject to special tax regulations, including the annual marking to market of open positions.

Perpetuals are a type of contract that allows traders to speculate on the future price of an asset without actually owning it. These contracts use a funding rate to balance the price of the perpetual with the spot price of the underlying asset. Traders can choose to take either long or short positions. When traders want to open and maintain positions, they deposit collateral. As the price of the underlying asset changes, traders can realize either profits or losses. Some popular DeFi protocols that offer perpetuals are Perpetual Protocol and dYdX.

In terms of taxation of perpetual contracts, the capital gains tax is applied unless a regulated futures contract exchange (CME). Therefore, profits and losses from closed contracts fall under the capital gains tax scope. 

In rebasing tokens, the number of tokens in circulation changes automatically based on the token's price. The token's supply is controlled by an algorithm that can mint new tokens or burn existing ones as necessary. Although these tokens offer unique investment opportunities, they are considered high-risk due to their constant value fluctuations. Additionally, many of these tokens have limited liquidity and smaller market capitalizations, which can exacerbate the volatility and make it challenging to find favorable trading opportunities. Therefore, it is essential to conduct thorough research and understand the potential risks before investing in rebasing tokens. One of the most popular DeFi protocols that offer rebasing tokens is Ampleforth ($AMPL). 

As far as the taxes of rebasing tokens is concerned, the IRS has not provided any guidance. Rebasing tokens are fungible tokens, and as such, when sold, depending on the gain or loss realized, they are liable to CGT. Please consult with your tax advisor for further instructions on how to handle newly issued tokens or tokens burned as the market rebalances.

Wrapped tokens in DeFi represent the value of an underlying asset, such as a cryptocurrency or traditional asset, like gold or fiat currency. They allow users to interact with assets that are not natively supported on a specific blockchain. This happens via a custodian, who holds the underlying asset and issues an equivalent amount of the wrapped token on the destination blockchain. 

Wrapped tokens can be traded on various DEXs and redeemed for the underlying asset when needed. Some popular wrapped tokens include Wrapped Bitcoin (WBTC) and RenBTC, both pegged to the value of Bitcoin on another chain (Ethereum). Overall, wrapped tokens provide a way for cross-chain interoperability in the DeFi ecosystem.

Regarding taxes on wrapped tokens in DeFi, there can be two ways to infer the tax rules. 

Exchanging wrapped tokens for other cryptocurrencies can be considered a disposal of assets, meaning it needs to be declared as it constitutes a crypto-to-crypto trade. Remember that when a token is wrapped, it typically results in a benefit for the holder that is distinct from the benefit afforded by the original asset because it gives access to more protocols. 

However, the IRS hasn't issued any guidance regarding wrapped tokens taxation, so treating the act of wrapping cryptocurrencies as equivalent to holding the same cryptocurrency (typically wrapped assets hold the same market value) means that it's not a non-taxable event. 

If you hold wrapped tokens, it's crucial to understand how wrapping affects your taxes. Please consult with a tax professional to understand the tax implications of wrapped tokens and their specific tax treatment. To ascertain the precise tax ramifications, evaluate each wrapping circumstance on an individual basis.

These protocols are designed to protect users against risks in the DeFi ecosystem, including smart contract failures, oracle malfunctions, liquidity draining, hacking incidents, and many more. It's implemented via smart contracts that pool funds from investors to provide coverage. Users who acquire the insurance can file a claim if a covered event occurs and they receive a payout from the insurance protocol. The flow of funds starts with users depositing funds into a smart contract pool, which is invested to generate returns for the protocol and provide coverage against potential claims. If no claims are made, the returns are distributed among the investors. If a claim is made, the protocol pays out the necessary funds to the user who has suffered a loss. Popular DeFi insurance protocols include Nexus Mutual and InsurAce. They offer an alternative to traditional insurance, with decentralized protocols that provide coverage in a transparent and trustless manner. 

The question of whether crypto insurances are tax-deductible is a complex topic that requires careful analysis. Generally speaking, if an investor pays for an insurance policy on their investments, this cost can be considered a deductible expense against any income generated from those investments (if payments are for a business). However, the specific rules around deductibility will depend on a variety of factors, including the type of insurance policy, the amount of the premium paid, and the nature of the investment income earned. It is highly recommended that individuals seeking to navigate Insurance Protocols on DeFi should seek further assistance from a trusted financial advisor or tax professional to ensure compliance with applicable regulations and to minimize the risk of any potential financial or legal issues.

Flash loans allow users to borrow funds without collateral for a short period (typically less than one block confirmation). They allow users to borrow funds from a lending pool, execute a specific trading strategy, and repay the loan within the same transaction. If the user fails to repay the loan, the transaction is reversed, and the flash loan is canceled. However, the amount spent on gas fees is not reimbursed.  Some popular DeFi protocols that offer flash loans include Aave and Uniswap, and the repayment of the loan is typically made in the same cryptocurrency that was borrowed.

Flashloans are similar to borrowing transactions, but they happen much more quickly. When you take out a flash loan, you are effectively buying and selling an asset. Any profits made from selling cryptocurrency assets are subject to Capital Gains Tax. 

Play-to-earn games in DeFi are a new concept in which players can earn cryptocurrency by playing blockchain-based games. These games offer a seamless way to earn rewards. Players can earn cryptocurrencies by performing in-game activities like completing quests, solving puzzles, and more. The flow of funds in play-to-earn games involves players earning tokens by playing the game, and then these tokens can be sold on various exchanges for other cryptocurrencies or fiat. Users can also stake these tokens in liquidity pools to earn additional rewards.

Some popular protocols that offer play-to-earn games include Axie Infinity (players collect, breed, and battle fantasy creatures known as Axies), Star Atlas (a space-themed game where players can explore and conquer the galaxy), and many more.

There isn't any definitive advice on the taxes of gamified DeFi at the moment. It is crucial to remember that earning money through these activities may still be subject to taxes. Depending on the token's fair market value on the day you acquired it, income tax may probably need to be paid if you obtain new tokens from P2E games. Besides that, the money you make from selling or exchanging the tokens you earn can be taxed under CGT. 

Gas fees that are incurred during the acquisition of a cryptocurrency asset are included in your cost basis. However, gas fees that cannot be linked explicitly to the acquisition of the asset are not considered deductible according to current guidelines, even though it could be argued that they are necessary costs associated with acquiring the asset. If you have accumulated substantial gas fees, it is recommended to seek guidance from a tax advisor to assist you in navigating this issue. This will help you determine which fees are deductible and which are not.

The Expert Guide to DeFi Taxes in the US (2023)

If you're involved in DeFi, you've likely heard of Aave. The popular decentralized lending platform allows you to earn interest on your crypto holdings or borrow against them. In May 2023, the protocol had a total value locked (TVL) of nearly USD 5 billion across several chains. However, things can get confusing for investors when it comes to Aave taxes. In this guide, we'll explore the tax implications of interacting with the Aave protocol, explaining what's taxable and what's not.

What Aave Users Should Know About Taxes - Accointing by Glassnode

AAVE is a DeFi protocol that allows users to lend, borrow, and earn interest on cryptocurrencies without the need for intermediaries like centralized exchanges. It offers several features, including flash loans, lending, borrowing, and collateral swaps.

Interacting with the AAVE protocol is done through smart contracts, it is one of the most well-known Ethereum-based DeFi platforms and is also deployed on Polygon, Avalanche, and other chains.

The platform provides the interest-bearing aTokens, designed to make it easier for users to access and move collateral on the platform. aTokens represent a portion of the underlying asset in a decentralized, non-custodial manner and can be used for lending, borrowing, or transferring value between Aave users.

Aave allows users to borrow and lend cryptocurrencies like Bitcoin, Ethereum, USD coin, Uniswap, and many more. If you lend, you earn interest. Conversely, in you borrow on Aave, you pay interest. Users who supply their crypto assets to the protocol and earn interest receive a corresponding amount of aTokens, which they can choose to trade or hold.

The protocol has gone through several iterations. The initial version, Aave V1, mainly focused on allowing users to lend and borrow a limited number of cryptocurrencies. Aave V2 was launched to provide a more robust and flexible user experience, allowing lending and borrowing an expanded range of cryptocurrencies. It also introduced new features such as the ability to switch between fixed and variable interest rates and flash loans, which are short-term loans that do not require collateral.

The latest, Aave V3, offers greater capital efficiencies, increased security, and cross-chain functionality with increased decentralization across the governance of the protocol. Some of the new features introduced include instant liquidity transactions, efficiency mode (eMode), isolation mode, siloed borrowing, and supply borrow caps. For more detailed information about Aave and its version differences, you can refer to their documentation.

While AAVE is considered a relatively safe platform for DeFi transactions, two sources of risk to consider when using Aave are liquidation risk and smart contract risk.

Liquidation risk relates to the scenario when the value of the crypto collateral you deposited falls below a certain threshold, and the system automatically sells the collateral to repay the crypto loan.

On the other hand, smart contract risk involves the potential for code vulnerabilities or exploits, which can lead to unexpected financial losses. It's important to keep these risks in mind when using Aave and to take appropriate precautions to mitigate them.

As DeFi gains traction among crypto holders owing to the capabilities it offers compared to traditional financial (TradFi) institutions, more people are using Aave for their lending and borrowing needs. However, if you realize a profit from these activities, there will be tax implications.

As you may know, the Internal Revenue Service (IRS) treats cryptocurrency as property. Any gains or losses from crypto assets must be reported on your tax return. When using Aave, there are several tax liability considerations, depending on the transaction type. Let’s look at the tax rules for common transactions involved in using the protocol.

The IRS has not yet issued specific guidance on taxable events for AAVE or other DeFi protocols. However, it’s generally recommended to take a conservative approach based on prior IRS guidance pertaining to crypto assets. You should accurately calculate and report the gains, losses, and income from your Aave investing activity.

Certain activities when using Aave may trigger a taxable event. Some of these include:

- selling or exchanging aTokens for another cryptocurrency

When you lend funds on Aave, you receive aTokens in return, which represent your supplied assets in the liquidity pool. The interest earned on supplied funds is paid out in the form of additional aTokens.

The IRS has not issued specific guidance on the taxation of lending funds on the Aave protocol, so it's best to take a conservative approach based on prior guidance provided which suggests that lending crypto on Aave is subject to taxation because in return for providing funds you get aTokens in a 1 to 1 proportion, meaning that it can be seen as a crypto to crypto trade.

The AAVE protocol offers a feature called flash loans that is intended for developers. It basically enables you to borrow any quantity of assets for a brief period of time (typically a single block transaction) without having to provide any collateral. The catch is that the flash loan can be correctly executed only if the liquidity is returned to the protocol; otherwise the transaction will be reverted. In the absence of a specific IRS guidance on the taxation of flash loans, keep in mind that any profit generated through this feature is subject to CGT.

A conventional approach to the taxation of will dictate that these transactions incur a taxable event. First, when a lender receives tokens as an incentive for providing funds, the value of these tokens is generally categorized as income and is subject to income tax at the fair market value (FMV) when received. Moreover, if the lender sells or exchanges these tokens later, they may owe capital gains tax on the difference between the value of the tokens when received and sold.

Staking is a way to earn rewards on your assets by locking them up for a period of time. The US tax authority has not issued specific guidance on how to tax staking rewards from AAVE or other DeFi protocols. Based on prior instruction issued for rewards form activities such as mining or airdrops,  it's better to take a conservative approach and establish that staking rewards are taxable income, based on the fair market value at the time of receipt. 

For example, if you stake 100 AAVE tokens and receive additional 10 aTokens in rewards, the value of those rewards will be taxed as income at the time of receipt. Keep in mind that if you later trade your reward tokens, you'll need to pay capital gains taxes on any profits you make.

The IRS has not issued any specific guidance on how to tax borrowing transactions from AAVE or other DeFi protocols. To understand this better, let's take a look at the transaction flow when borrowing assets on Aave. First, you need to supply some assets before borrowing, this transaction will incur a taxable because you will be receiving aTokens in exchange for the supplied assets.

By taking out a collateralized crypto loan, you retain ownership of the assets you used as collateral. However, you lose the ability to trade them during the repayment period. In case you have to exchange cryptocurrency to repay the loan, this conversion may be taxable as it represents a crypto-to-crypto trade, meaning that is subject to capital gains.

Moreover, if the value of your collateral falls below the accepted risk level, your position may be liquidated. This means that AAVE will sell your collateral to repay your crypto loan. When your collateral is seized, you don’t lose it for $0. Instead, it is used to repay liquidity providers the amount that you owe based on its fair market value at the time the liquidation occurs.

Since your loan is repaid, you no longer owe anything to the lender. Because of the cancellation of debt (COD) income, however, you could actually record a gain from the liquidation, since you still control the borrowed assets which would be taxed as COD income. This is a grey topic on crypto taxation and may be subject to special tax rules, so it is advisable to always consult with a tax advisor based on your specific situation.

When you swap assets, you are essentially selling one crypto asset and buying another. This means that you may have to pay capital gains taxes on any profits you make. The amount of capital gains taxes you owe will depend on the length of time you held the token you sold and the profit realized. If you held the token for less than a year, you will be taxed at the short-term capital gains rate, meanwhile, the long-term capital gains rate will apply if it's held for more than a year.

There are several non-taxable transactions that you should be aware of as Aave user.

Using Aave tokens to vote on proposals does not involve the sale or exchange of cryptocurrency. The action has no immediate financial gain or loss and is thus a non-taxable activity.

For example, if you own shares in a company, you would not have to pay tax on the value of your shares simply because you voted on a proposal at the company's annual meeting. The same principle applies in the crypto space. When you vote on a proposal, you're simply exercising your right as a token holder to have a say in how the protocol is governed.

Transaction fees are incurred when you move funds in and out of your Aave account – such as transferring funds to a different wallet or withdrawing funds to a bank account. These fees are necessary for the normal operation of the platform. The IRS has not issued specific guidance on whether paying gas fees represents a taxable event. However, they may impact the cost basis, so you must properly track and report them.

Internal transactions on Aave are not taxable because they don't involve any kind of asset swap. These types of transactions occur when users move their funds from one Aave account to another for lending and borrowing purposes. The funds remain under the control of the user at all times, and no third-party is involved in the exchange. As a result, these internal transfers are not subject to tax.

How to File Taxes on my Aave Transactions?

To calculate your taxes, you will need to determine your cost basis and income. Your cost basis is the price you paid for the cryptocurrency, plus any fees associated with the purchase. Your income is the fair market value of the cryptocurrency when you earned it, such as through mining or staking. You must report all of your cryptocurrency transactions on your tax return. You can use Form 8949 and Schedule D to report your capital gains and losses from your crypto activity on Aave.

Calculating Crypto Taxes for Aave Transactions

Calculating crypto taxes for Aave transactions can be complex and time-consuming, but it is necessary to ensure compliance with IRS guidelines. The tax implications of using Aave include capital gains taxes on profits from crypto trades, as well as income tax on interest earned from lending or staking transactions.

When calculating crypto taxes for transactions on Aave and other DeFi protocols, it’s essential to understand how the cost basis for each transaction is determined. The cost basis is essentially the price of a crypto asset at the point when you first acquired it. To determine the cost basis accurately, you need to take into account the date, any fees you paid, and the value of the asset in US dollars. Handling these calculations properly ensures that your taxable gains are accurately reflected and documented for tax purposes.

If you still have doubts about how the tax treatment of crypto assets in the US, check out our regularly updated 2023 US crypto tax guide written by tax experts. 

No, Aave does not report to the IRS. As a decentralized protocol, it doesn't have the capacity to collect or report user data to the IRS. However, US taxpayers are still responsible for reporting all taxable Aave transactions on their annual tax return.

How Can a Crypto Tax Calculator Help With Aave Taxes?

Using a reliable crypto tax calculator can simplify the process of reporting your Aave transactions. When using Accointing, for instance, all you need to do is connect your wallets to the crypto tax platform.  The tool then automatically calculates the cost basis and capital gains/losses from your lending and borrowing transactions for the wallets you imported. With multiple integration methods available, users can generate a tax report fast, in a few simple steps. The platform allows you to identify unknown currencies, internal transactions, missing funds, and solve unclassified transactions issues.

Aave is a DeFi protocol that allows users to borrow and lend cryptocurrency. When using Aave, it's important to understand the tax implications of your transactions.


With a crypto tax software, you can report your transactions accurately and continue interacting with DeFi protocols while staying compliant. Don't let taxes prevent you from taking advantage of everything Aave has to offer

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The information contained in this guide, including any supplemental materials, is for general information purposes and does not constitute financial, investment, legal, or tax advice. The present content is not intended as a thorough, in-depth analysis, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties. Please consult your tax advisor. 

What Aave Users Should Know About Taxes

Are you a crypto enthusiast who has recently dabbled in PancakeSwap? With low fees, high liquidity, many features, and a user-friendly interface, the DEX has attracted a massive following in the DeFi space. As of April 2023, the Total Value Locked (TVL) on PancakeSwap is over $2.1 billion, according to Defillama. But financial success also entails tax obligations. In this regularly-updated expert guide, we’ll explain everything you need to know about taxes related to PancakeSwap trading, so you can stay compliant and maximize your profits.

The Complete PancakeSwap Taxes Guide 2023 - Accointing

PancakeSwap is a decentralized exchange (DEX) built on the Binance Smart Chain (BSC). It allows users to trade cryptocurrencies without the involvement of a central authority or an intermediary. Pancakeswap also offers staking, on-chain games, yield farming and other DeFi activities that allow users to earn additional tokens by locking up their assets. 

CAKE is the native currency of PancakeSwap, a decentralized exchange for trading cryptocurrencies. It has a capped supply of 750 million and is deflationary through “token burning”. Users can buy, win, or farm CAKE tokens and use them for trading, swapping, and collecting liquidity fees. Staking CAKE tokens can earn rewards and allow voting on governance decisions.

Yes, you likely have to pay taxes on your Pancakeswap transactions. Anytime you trade cryptocurrencies, provide liquidity, stake, or participate in yield farming on the Pancakeswap dApp, you may incur a taxable event. 

On Pancakeswap, you can swap cryptocurrencies, provide liquidity to the platform, stake your tokens for rewards, perpetual trading, bridge funds, play on-chain games (like prediction), do yield farming, lottery, trade NFTs, and participate in Initial Farm Offerings (IFO). Each of these activities has different tax implications that we explain in detail in the sections below.

Staking involves locking up your crypto assets, such as BNB or CAKE, in a Pancakeswap staking pool. By doing so, you help secure the network and earn a share of the transaction fees generated by the platform. Staking rewards can be earned in CAKE, the native cryptocurrency of Pancakeswap, or other tokens, depending on the specific staking pool.

Yield Farming, on the other hand, involves providing liquidity to a liquidity pool on PancakeSwap by depositing token pairs. For example, you could deposit BNB and BUSD to create a BNB/BUSD liquidity pool. That way you earn a portion of the trading fees generated by the platform for this pair. Additionally, you can earn additional rewards in the form of CAKE by staking your liquidity pool tokens.

How is Yield Farming and Staking on PancakeSwap Taxed?

The IRS hasn’t made an official statement regarding the taxation of staking and yield farming income. However,  given that it works similarly to mining income, it makes sense to tax staking and yield farming income under the same guidelines. The conservative approach is to tax staked coins as ordinary income based on their fair market value at the time of receipt.

Yield farming and Staking rewards on PancakeSwap are considered income and thus become subject to income tax. If you receive crypto as compensation it will be taxable at its fair market value (FMV) at the time of receipt. It’s important to keep track of the value of the rewards at the time they are received and report them accurately on your tax return.

PancakeSwap also offers NFTs (non-fungible tokens), which are unique digital assets that represent ownership of a specific item or piece of content. If you buy or sell NFTs on PancakeSwap, you may incur capital gains or losses that need to be reported on your tax return.

Yes, NFTs are currently subject to both ordinary income tax and capital gains tax (CGT). The Internal Revenue Service (IRS) Notice 2014-21 and FAQs define NFTs as virtual currencies. NFTs are clearly mentioned in the new Form 1040 instructions as falling under the definition of a “digital asset,” which means they are also taxed as property subject to capital gains tax. Although it’s possible that the IRS will eventually classify NFTs as collectibles, NFT holders should be aware of any new guidance and seek advice from a tax expert as needed

If you buy or sell NFTs on PancakeSwap, you may incur capital gains or losses that need to be reported on your tax return. As trading NFTs represent a crypto-to-crypto trade any gains are subject to taxation. You should be aware that NFTs are now taxed on income and capital gains if you own or invest in NFTs. NFTs are taxed like property, and Form 8949 is used to report gains or losses from the disposition of NFTs.

PancakeSwap Perpetuals is a feature that allows traders to engage in leveraged crypto asset trading. Traders can buy or sell an underlying asset at a fixed price, without an expiration date. 

PancakeSwap offers 100x leverage, which means that traders can amplify their gains or losses by up to 100 times. For example, if a trader buys a perpetual contract for $1,000 with 100x leverage, they will control $100,000 worth of the underlying asset. However, leverage trading also comes with risks. If the market moves against you, you can lose your entire investment. 

The IRS hasn’t issued any guidance regarding taxation on perpetual transactions on DeFi. However, it’s likely that any profits from trading are subject to capital gains. 

Please consult with your tax advisor to ensure that you understand the tax implications of trading crypto perpetuals on DeFI platforms since the tax regulations regarding this type of transaction can be complex and may vary based on your individual case.

The Bridge on PancakeSwap is a feature that enables users to quickly and efficiently transfer tokens between different blockchain networks. It requires depositing tokens on one network, converting them into wrapped tokens that can be transferred to the destination chain, and then converting them back to the original asset. 

Yield Farming Taxes: The Complete Guide 2023

The Expert Guide to DeFi Taxes in the US (2023)

What Aave Users Should Know About Taxes

The Complete PancakeSwap Taxes Guide 2023

DeFi Taxes for Yearn Finance Users: A Comprehensive Guide