Do I Pay Tax on Yield Farming or Liquidity Pool Rewards

What Are Yield Farming and Liquidity Pools

Yield farming involves depositing cryptocurrency into a DeFi platform to earn rewards, often in the form of interest, tokens, or a share of transaction fees.

Liquidity pools are smart contracts where users deposit tokens to provide liquidity for decentralised exchanges. In return, they earn rewards or fees from trades made using those pools.

Although these activities seem like passive investments, they involve complex transactions that HMRC classifies as taxable events under UK tax law.

HMRC’s View on DeFi and Crypto Rewards

HMRC does not have a single set of rules for yield farming or liquidity pools. Instead, it looks at each situation individually to determine whether rewards are taxed as income or capital gains.

The deciding factors include:

• The nature of the transaction (are you lending, swapping, or staking assets).

• Whether you have control over your tokens while they are locked in a pool.

• The type of reward you receive (interest-like returns, tokens, or fees).

• The frequency and purpose of your activity (occasional investing or regular trading).

HMRC’s guidance, published in its Cryptoassets Manual, treats most DeFi rewards as taxable either when received or when the underlying crypto is disposed of.

Income Tax on Yield Farming and Liquidity Pool Rewards

If your rewards are received regularly or resemble interest or income, they are usually subject to Income Tax.

This applies when:

• You earn tokens or fees as ongoing rewards for providing liquidity.

• The platform automatically credits you with new tokens representing your yield.

• You are earning a predictable or consistent return similar to savings interest.

In these cases, HMRC expects you to report the fair market value in pounds sterling of the rewards at the time you receive them. This value is added to your total taxable income and taxed according to your marginal income tax rate (20%, 40%, or 45%).

Example:
You deposit £10,000 worth of stablecoins into a DeFi platform and earn £800 worth of rewards during the year. The £800 is taxed as income in the tax year you receive it, even if you keep it in crypto form.

Capital Gains Tax on DeFi Transactions

Many yield farming and liquidity pool arrangements also trigger Capital Gains Tax (CGT). This is because depositing or withdrawing tokens can count as a disposal under HMRC rules.

For example:

• If you deposit tokens into a liquidity pool and receive new pool tokens in return, HMRC may treat this as a disposal of your original tokens and an acquisition of new ones.

• When you later withdraw from the pool, another disposal occurs, creating a gain or loss based on the change in token value since the deposit.

These gains are added to your other capital gains for the year and taxed at 10% for basic rate taxpayers or 20% for higher and additional rate taxpayers. You can offset any losses or use your annual CGT allowance (£3,000 for 2025–26).

Dual Taxation: When Both Apply

In some situations, both Income Tax and Capital Gains Tax can apply.

For instance, you might earn income when receiving new tokens from a liquidity pool, and then later make a capital gain when you dispose of or exchange those tokens for another cryptocurrency.

An accountant can help you distinguish between the two and avoid double taxation by ensuring that each transaction is categorised correctly.

Record Keeping for DeFi Transactions

HMRC requires detailed records of every crypto transaction, including DeFi activity. You should keep:

• The date and time of each deposit, withdrawal, and reward.

• The amount and type of crypto involved.

• The market value in pounds at the time of each transaction.

• Details of transaction fees and smart contract addresses.

Because DeFi platforms often operate across multiple blockchains and use different tokens for rewards, it is essential to use crypto tax software or professional assistance to track everything accurately.

Reporting Yield Farming and Liquidity Pool Rewards

If your DeFi activity is modest, you can include it in your annual Self Assessment tax return. You will need to:

1. Report all crypto income in the “Other Income” section if it qualifies as taxable income.

2. Include capital gains from disposals in the “Capital Gains Summary” section.

3. Keep records and supporting documents for at least five years after the end of the tax year.

If you trade frequently or earn large sums, you may also need to register for Self Assessment with HMRC if you are not already doing so.

Example of How DeFi Tax Works in Practice

Suppose you deposit £5,000 worth of Ethereum into a DeFi platform. In return, you receive pool tokens worth £5,000. Six months later, those pool tokens are now worth £6,000, and you withdraw your funds, receiving £6,000 worth of Ethereum.

• The £1,000 gain is a capital gain on the change in value of your pool tokens.

• If the platform also rewarded you with £300 worth of governance tokens during the period, that £300 is taxable income.

You must report both on your Self Assessment return.

How an Accountant Can Help

The tax treatment of DeFi transactions can vary depending on the structure of the platform and the type of rewards you earn. An accountant familiar with crypto taxation can:

• Review your transactions and identify which are taxable.

• Distinguish between income and capital gains to avoid overpaying tax.

• Calculate the fair market value of rewards in pounds at the correct dates.

• Use crypto tax software to reconcile activity across multiple platforms.

• Help you file accurate tax returns and claim allowable losses.

Professional advice is especially important if you are involved in complex DeFi strategies or earn significant rewards, as HMRC’s approach is still evolving.

Summary

Yes, yield farming and liquidity pool rewards are taxable in the UK. HMRC generally treats these rewards as income when received and may also charge Capital Gains Tax when assets are disposed of. The exact treatment depends on how the platform operates and the type of return you earn.

To stay compliant, keep detailed records of all transactions, calculate values in pounds at the time of each event, and report both income and gains on your tax return. With professional guidance, you can ensure your DeFi activity is accurately reported and avoid unexpected tax bills later.