Tax treatment of crypto returns from liquidity pools and staking rewards

Traditional traders and investors in crypto assets aim to derive a return from the crypto world through straightforward acquisition and sale transactions. However, there are persons (individuals but also entities) who aim to derive returns from their crypto assets through more innovative mechanisms, such as providing liquidity in liquidity pools and staking.  

What are Liquidity Pools in Cryptocurrency

A liquidity pool is a collection of funds locked in a smart contract that enables decentralized trading on platforms known as decentralized exchanges (DEXs). Users, called liquidity providers (LPs), deposit pairs of tokens into these pools, which facilitate trading by allowing other users to swap tokens directly from the pool without the need for a traditional order book. This enables decentralized trading, lending, and other financial activities. LPs supply two tokens (e.g., ETH and USDT) to a pool, and in return, they receive LP tokens representing their share. LPs earn a portion of trading fees proportional to their share of the pool, and sometimes additional incentives like staking rewards.

What is Staking in Cryptocurrency

Staking involves locking up cryptocurrencies in a network to support its operation, security, and consensus mechanism—commonly used in Proof of Stake (PoS) and similar protocols. The main purpose is to validate transactions, secure the network, and participate in governance. Users deposit or "stake" their tokens into a network validator or staking contract, and earn rewards in the form of additional tokens for participating honestly and maintaining network integrity. Often, staked tokens are locked for a certain period, during which they cannot be transferred or sold.

How are rewards from Liquidity Pools and Staking taxed

Overall, most jurisdictions (US, Canada, EU, UK, Australia) apply the same tax treatment to rewards from liquidity pools and staking, namely, considered as taxable income at the time they are received. The fair market value of the rewards at the time of receipt is included in the income to be brought to tax. 

However, any gains from the subsequent appreciation and eventual sale are not always brought to tax in the same way by all countries. Whereas most countries tax any subsequent gain from the sale, Malta differentiates between subsequent disposals that are of a trading and of a capital nature, with the latter being outside the scope of tax. 

If you engage in liquidity pools and staking activity, speak to our tax team at Quazar, to understand how to ensure proper reporting of your returns for tax purposes. Moreover, our team can assist with the necessary guidance to ensure that you maximise the tax benefits that different jurisdictions can offer and adapt such to your circumstances. 

Get in Touch:

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Josef Mercieca

jmercieca@quazar.mt / +356 2388 4600