Worked Example: ETH on Aave
A step-by-step walkthrough of depositing ETH collateral on Aave V3, borrowing stablecoins, repaying, and handling liquidation.
Worked Example: ETH Collateral on Aave → Borrow Stablecoins
Let's walk through a complete, realistic DeFi scenario and analyse every tax event.
Scenario: A user deposits 10 ETH (worth £25,000 at the time) into Aave V3 as collateral and borrows 15,000 USDC (worth ~£12,000).
Step 1: Analyse Aave's Smart Contract
Aave V3 locks collateral in a smart contract. The protocol cannot freely deal with the collateral — it is ring-fenced and only released on repayment or liquidation. Aave does not re-lend collateral tokens (unlike some other protocols).
Conclusion: Beneficial ownership is retained by the borrower. No disposal occurs on depositing the ETH.
Step 2: Tax Treatment of the Borrowed USDC
- The 15,000 USDC is an acquisition by the borrower.
- Acquisition cost = the obligation to repay 15,000 USDC (treated as "money's worth" = ~£12,000 at the time of borrowing).
Step 3: What Happens When the User Spends the USDC
- If the user swaps the 15,000 USDC for GBP, that is a disposal of USDC.
- Gain/loss = proceeds (GBP received) minus acquisition cost (~£12,000).
- If USDC has remained pegged, the gain is minimal or zero (but must still be reported if above the annual exempt amount).
Step 4: Repaying the Loan
- The user buys 15,000 USDC + interest to repay the loan.
- Buying the USDC is an acquisition; transferring it back to Aave to repay is a disposal.
- Interest paid in USDC is also a disposal of those USDC tokens.
Step 5: Withdrawing Collateral
- The 10 ETH is returned to the user.
- Since beneficial ownership was retained (no disposal at deposit), there is no CGT event on withdrawal.
- The ETH remains in the user's Section 104 pool at its original cost basis.
Step 6: If Liquidation Occurs Instead
- Aave sells some/all of the 10 ETH to repay the loan.
- s.26(2) TCGA 1992 applies — this is treated as a disposal by the borrower.
- Gain/loss = market value at liquidation minus pooled cost basis.
- Any liquidation penalty (Aave's 5% bonus to liquidators) is NOT deductible.
Summary Table
| Event | CGT Event? | Income Tax Event? |
|---|---|---|
| Deposit ETH as collateral | No (Aave locks, doesn't re-use) | No |
| Receive borrowed USDC | No (acquisition) | No |
| Sell/swap borrowed USDC | Yes (disposal of USDC) | No |
| Receive yield on deposited ETH (aTokens) | Depends on structure | Possibly (miscellaneous income) |
| Repay USDC loan | Yes (disposal of USDC) | No |
| Withdraw ETH collateral | No | No |
| Liquidation of ETH collateral | Yes (deemed disposal via s.26) | No |
Important caveat: This analysis applies to Aave V3 specifically. Other protocols may handle collateral differently — each must be analysed individually based on its smart contract terms. Some protocols DO re-lend or rehypothecate collateral, which would likely constitute a transfer of beneficial ownership and trigger a disposal.
Explain Like I'm 5
This is a step-by-step story about putting your digital coins into a special app called Aave. You leave coins as a deposit, borrow different coins, spend them, then pay them back. Each little step might mean you owe the government something. It is like going to a toy library, leaving your teddy as a deposit, borrowing a board game, playing with it, and returning it. Every swap along the way gets written down.
Key Takeaways
- Aave V3 locks collateral — no disposal on deposit because beneficial ownership is retained.
- Borrowed stablecoins have an acquisition cost equal to the repayment obligation.
- Every swap, sale, or repayment of borrowed tokens is a separate CGT event that must be tracked.
- Liquidation triggers a deemed disposal via s.26(2) — and the penalty is not deductible.
- Other protocols may handle collateral differently. Always analyse the smart contract terms.
CoreFi tracks your DeFi transactions and calculates gains automatically — including collateral, borrows, and liquidations.
Start tracking your DeFi portfolioEducational only - not financial advice