DeFi Yield Farming Tax UK: How HMRC Taxes Liquidity Provision

Yield farming — providing liquidity to DeFi protocols for rewards — creates multiple taxable events that require careful tracking.

The Core Tax Events

Action	Tax Event
Deposit tokens into a liquidity pool	Not a disposal (if same tokens back)
Receive LP tokens	Not a disposal
Earn trading fees	Miscellaneous income at receipt
Receive governance tokens	Miscellaneous income at receipt
Withdraw different tokens than deposited	Disposal
Withdraw same tokens	Not a disposal

Providing Liquidity

Scenario	Tax
Deposit ETH + USDC into Uniswap pool	Not a disposal
Receive UNI-V2 LP tokens	Not a disposal
Pool earns trading fees	Income (value at receipt)
Withdraw ETH + USDC (proportions changed)	Disposal of LP tokens

The deposit itself is not a disposal. But the balance of tokens changes over time (impermanent loss), which is realised on withdrawal.

Fee Income

Fee Type	Tax Treatment
Trading fees from pool	Miscellaneous income
Protocol rewards (in native token)	Miscellaneous income
COMP, SUSHI, CRV rewards	Miscellaneous income
Staking LP tokens for extra rewards	Miscellaneous income

All rewards are taxed at market value when received.

Governance Token Airdrops

Scenario	Tax Treatment
UNI airdrop to historical users	No action → CGT on sale
Liquidity mining rewards (ongoing)	Miscellaneous income
Retroactive airdrop for past activity	No action → CGT on sale

The LP Token Problem

When you deposit into a pool, you receive LP tokens (e.g., UNI-V2). These represent your share of the pool.

Event	Tax Treatment
Receive LP tokens	Not a disposal
Transfer LP tokens to another wallet	Disposal of LP tokens
Redeem LP tokens for underlying assets	Disposal of LP tokens
Stake LP tokens in a rewards contract	Not a disposal

Tracking Cost Basis

Asset	Cost Basis
LP tokens	Value of deposited assets
Yield farming rewards	Market value when received
Governance tokens	Market value when received

Record Keeping for Yield Farming

Record	Why
Date of deposit	Start of position
Deposited tokens and amounts	Cost basis
LP token amount received	Position tracking
Each reward received (date, token, value)	Income tracking
Date of withdrawal	Disposal event
Withdrawn tokens and amounts	Gain/loss calculation
Transaction hashes	Proof for HMRC

Common Mistakes

Mistake	Consequence
Not tracking LP token cost basis	Wrong gain calculation on withdrawal
Ignoring small reward claims	Each is a taxable event
Forgetting impermanent loss	Realised on withdrawal
Not reporting governance token airdrops	Missed income

Bottom Line

Yield farming generates taxable income from fees and rewards. Depositing into a pool is not a disposal; withdrawing different tokens is. Track every reward at market value when received. LP tokens have a cost basis that must be tracked. Keep detailed records — yield farming is one of the most complex areas of crypto tax. Consider using DeFi-specific tax software.