DeFi Tax UK: How HMRC Taxes Lending, Staking, and Liquidity

DeFi creates awkward tax situations because HMRC treats each interaction with a smart contract as a potential taxable event. The question that drives almost every DeFi tax analysis is beneficial ownership: do you still control your tokens, or has ownership effectively transferred to the protocol?

Lending

If a protocol can use, lend out, or rehypothecate your tokens, HMRC is likely to treat your deposit as a disposal, which means Capital Gains Tax applies at that point. If the protocol merely holds your tokens in custody without using them, it probably is not a disposal. Most mainstream DeFi lending protocols, including Aave and Compound, fall into the first category. You have not sold anything, but you may already have a taxable gain.

Staking rewards

Rewards are generally taxed as miscellaneous income at the moment you receive them. The taxable amount is the sterling market value of the tokens on the date of receipt. That same value then becomes your cost basis. So when you eventually sell those staking rewards, CGT applies to any further gain above the income figure you already reported. You are taxed twice on growth, but not on the same growth twice.

Liquidity provision

When you deposit two tokens into a liquidity pool, you typically receive LP tokens in return. HMRC's likely position is that you have disposed of both original tokens at that point, triggering CGT on any gains. Impermanent loss does not create a separate deductible loss; it is baked into the gain or loss you calculate when you withdraw. Record your cost basis for both deposited tokens before you add liquidity, because you will need those figures later.