What Is DeFi and How Is It Taxed in the UK

What is DeFi

DeFi stands for decentralised finance, an ecosystem of blockchain-based applications that offer financial services without relying on traditional institutions like banks or brokers.

Instead of using a central authority, DeFi platforms run on smart contracts self-executing programs stored on blockchains such as Ethereum, Solana, or Binance Smart Chain. These contracts automatically manage lending, borrowing, trading, or staking transactions according to coded rules.

Popular DeFi platforms include Uniswap, Aave, MakerDAO, and Compound. They allow users to:

• Earn interest by providing liquidity to pools

• Borrow crypto by offering collateral

• Swap or trade tokens directly between users

• Stake or lock up tokens to earn rewards

The main attraction of DeFi is that it removes intermediaries, allowing anyone with a digital wallet to access financial tools globally. However, the lack of central regulation makes DeFi taxation and record keeping far more complicated.

How HMRC views DeFi

HMRC does not have a specific tax category for DeFi. Instead, it applies existing tax principles based on the nature of the transaction.

Every DeFi action whether earning rewards, lending tokens, or swapping assets is assessed individually to determine whether it gives rise to Income Tax or Capital Gains Tax (CGT).

HMRC updated its DeFi tax guidance in 2022 to clarify how these rules apply. The key factor is whether you retain beneficial ownership of your crypto or transfer it to someone else as part of the transaction.

DeFi transactions that may be taxed

Lending or staking crypto

When you lend or stake your cryptocurrency on a DeFi platform, you may receive rewards such as new tokens or additional interest.

If you still retain ownership of the original tokens, the rewards are usually taxed as income, based on their market value in pounds at the time you receive them.

If the platform takes full control of your tokens for example, by pooling them with others or issuing you a different token in return the transaction may be treated as a disposal for CGT purposes. That means you could owe Capital Gains Tax on any increase in value since you originally acquired the tokens.

Yield farming

Yield farming involves moving crypto across multiple DeFi platforms to earn the highest possible return. Each movement or swap between tokens may trigger a taxable event.

You could face both:

• Income Tax on any new rewards or interest you earn, and

• Capital Gains Tax on gains made when swapping one token for another.

The complexity of yield farming makes accurate record keeping crucial, as dozens of small taxable events can occur in a single strategy.

Liquidity provision

When you provide tokens to a liquidity pool, you often receive a liquidity provider (LP) token in return. HMRC generally considers this a disposal, as you exchange one asset for another.

When you later withdraw your liquidity, another disposal may occur if the LP tokens have changed in value.

Any rewards or fees earned from liquidity provision are treated as income when received, with subsequent gains taxed under CGT rules.

Borrowing against crypto

If you use your crypto as collateral to borrow funds on a DeFi platform, HMRC does not normally treat the act of borrowing as a taxable event.

However, if the collateral is transferred to the platform’s control, it could be considered a disposal for CGT purposes.

You will also be taxed on any additional tokens or rewards earned while participating in the lending agreement.

Capital Gains Tax and DeFi

Most DeFi users will encounter Capital Gains Tax when disposing of tokens through swaps, withdrawals, or redemptions.

A disposal occurs when you:

• Exchange one cryptocurrency for another

• Receive new tokens in place of your originals

• Withdraw liquidity or staking rewards in a different form

To calculate your gain, subtract your original cost (including transaction fees) from the sterling value of the tokens you receive at disposal.

If your total gains across all crypto assets exceed the £3,000 CGT allowance for 2025–26, you will need to report and pay CGT through your Self Assessment tax return.

Income Tax and DeFi rewards

DeFi rewards are often taxed as income if they arise from an activity similar to earning interest or receiving payments for services.

Examples include:

• Earning staking rewards

• Receiving governance tokens as incentives

• Collecting yield from lending or liquidity pools

These rewards are taxed based on their market value in pounds at the time they are received. You may also have to pay CGT later if the tokens increase in value and you dispose of them.

Example:
You earn £200 worth of DeFi rewards in January. This is subject to Income Tax. Later, you sell those rewards for £300. The £100 difference is a capital gain and subject to CGT.

Reporting DeFi transactions to HMRC

DeFi transactions must be declared on your Self Assessment tax return if they generate taxable income or gains.

For Capital Gains Tax:

• Include total disposals, allowable costs, and net gains in the CGT summary section.

For Income Tax:

• Report staking or yield farming rewards as “Other Income” unless they form part of a business activity.

Keep detailed records including:

• Dates and values of each transaction

• Token types and quantities

• Wallet and exchange details

• The sterling value of rewards or disposals

• Transaction and gas fees

HMRC may request these records to verify your figures, so accuracy and consistency are essential.

Common challenges with DeFi tax reporting

DeFi’s decentralised structure makes it difficult to track transactions and convert them into pounds. Common challenges include:

• Lack of standardised reporting from DeFi platforms

• Complicated smart contract interactions

• Rapid token swaps that trigger multiple taxable events

• Tokens received without clear market values

Using crypto tax software can simplify this process by connecting to your wallets, converting prices to sterling, and generating reports suitable for HMRC.

Final thoughts

DeFi offers new financial opportunities, but it also comes with complex tax obligations. HMRC expects all DeFi users to report income and gains accurately, even when transactions do not involve traditional currency.

The key is to determine whether each transaction represents income or a disposal and to record the sterling value at the time it occurs. Good record keeping and the use of specialist tax tools will make it easier to stay compliant.

If your DeFi activity involves multiple platforms or high transaction volumes, consider speaking with a tax adviser who understands cryptocurrency. They can help ensure you pay only what you owe and nothing more while keeping your tax reporting in line with UK law.