Decentralised finance is the area of cryptoasset tax where HMRC's published guidance is least developed and where reasonable advisers can hold different views on the same facts. HMRC ran a consultation on DeFi lending and staking in 2022 and 2023, signalled its preferred direction of travel, and has continued to update the Cryptoassets Manual incrementally. The underlying tension is between treating each on-chain event as a disposal (the position that follows from a strict reading of the legislation) and treating economically equivalent positions as continuous holdings.
The core issue: beneficial ownership
HMRC's existing position is that depositing tokens into a DeFi protocol is potentially a disposal where beneficial ownership of the underlying tokens passes from the user to the protocol. The classic test case is lending. If a user deposits ETH into a lending market and receives an interest-bearing token in return, has the user disposed of the ETH? On a strict view, yes: the protocol now has the legal and beneficial right to use the tokens, and the user holds a different asset (the interest-bearing token) representing a claim on the pool.
This is harsh in practice because the user often intends to be in the same economic position, simply earning yield. The HMRC consultation acknowledged this and proposed a framework where qualifying DeFi lending and staking transactions would not be treated as disposals, with the yield instead taxed as revenue. The legislative response is still being developed, and in the interim taxpayers and advisers must apply current rules.
Yield farming
Yield farming typically involves depositing tokens into a liquidity pool, receiving an LP token in return, and earning protocol rewards in additional tokens. Under current guidance:
- Deposit: The deposit may be a disposal of the underlying tokens for CGT, with the LP token acquired at the market value at that point.
- Rewards: Rewards received during the farming period are typically taxable as miscellaneous income on receipt, valued in sterling.
- Withdrawal: Redeeming the LP token to recover the underlying tokens is a disposal of the LP token and acquisition of the underlying, again at sterling values on the date of the transaction.
The double layer of CGT and income tax can produce surprising outcomes, especially during a market downturn where the LP token has lost significant value but the rewards taken along the way were taxed as income at sterling values that have since fallen.
Impermanent loss
Impermanent loss is the economic loss a liquidity provider suffers when the relative price of pooled assets changes. It does not have a special tax label. The loss, if any, falls out of the standard CGT analysis when the LP token is redeemed and the underlying tokens are reacquired at their new market values.
Wrapping and bridging
Wrapping a token (for example, ETH to WETH, or BTC to WBTC) and bridging between chains raise the same beneficial ownership question. HMRC's stated position is that whether wrapping is a disposal depends on the legal substance: if the wrapped token represents the same legal right as the original (a one-for-one custody claim), wrapping may not be a disposal; if it represents a different right (a claim against a smart contract or custodian), it may be. The answer varies by protocol.
Borrowing
Where a user borrows against crypto collateral, the borrowing itself is not a disposal of the collateral. The collateral remains beneficially owned by the user. Interest expense is generally not relievable for an investor (only deductible against trading income or specific carve-outs), and there is no disposal until the collateral is sold or liquidated.
Reporting practicalities
The practical challenge with DeFi is data, not theory. A single DeFi user may have hundreds or thousands of on-chain interactions over a year, across multiple chains and protocols. Producing a defensible CGT and income computation requires:
- A complete export of all wallet activity across every chain used.
- Per-transaction sterling valuations.
- Classification of each event as deposit, withdrawal, reward, swap, fee, etc.
- Application of the same-day and 30-day rules across the pooled assets.
Crypto tax software helps but is rarely perfect on DeFi. Manual review of complex transactions (especially those involving non-standard contracts) is normally required.
Where we add value
PushDigits handles DeFi-heavy crypto portfolios where automated tools alone do not produce a complete or defensible return. We reconcile on-chain activity, apply the current HMRC analysis consistently and document the basis for any judgment calls. See our tax planning and Self Assessment pages, or book a consultation to walk through your activity.