Liquidity Mining: How To Tax Crypto Income

To enable trading on decentralized crypto trading platforms (DEX), these must be liquid, i.e. have sufficient amounts of different cryptocurrencies. Each user can temporarily give DEX tokens to the liquidity pool. In return, he gets a share of the fees collected from DEX – the reward in liquidity mining. As a rule, only trading pairs consisting of a collection of different crypto-tokens are made available to the DEX.

Three important times or periods are therefore taken into account when calculating the tax:

  1. Enter the liquidity pool by supplying two cryptocurrencies.
  2. The period of time to leave them in the liquidity pool.
  3. Leave the liquidity pool by removing the coins.

When you exit the pool, there may be a permanent loss because the prices of the cryptocurrencies provided as a trading pair are subject to fluctuations.

Again and again it can be seen that false incomes – in nature and amount – are reported to the tax office and accepted by them without being checked. In particular, all this is based on the following general assumptions without reflection:

  1. All crypto income is subject to full personal tax rate like other income and
  2. The entry and exit of a liquidity pool are tax-relevant facts.

Rewards like capital income?

In fact, the following picture emerges:

  • In many cases, the current income from liquidity extraction is recognized by the tax authorities as capital income and is therefore only subject to withholding tax (25 percent capital gains tax + 5.5 percent solidarity supplement = 27.75 percent).
  • Another advantage: as capital income, they do not increase the personal tax rate; unlike other income.
  • In many cases (from case to case) entry and exit from the liquidity pool is not to be considered a taxable event. In one case, this was confirmed by the Oberfinanzdirektion Frankfurt am Main.
  • There is no specific binding rule on how to tax liquidity extraction.
  • For liability reasons, tax advisors should generally not advise their clients to choose the most unfavorable taxation for the taxpayer.

Taxation of current income

The current income (proportionate fees or rewards) from liquidity extraction may be taxed as income from business operations, from capital assets or as other income.

Taxation as commercial income can be excluded, also according to the tax authorities’ current declarations in the letter from the Federal Ministry of Finance on the taxation of virtual currencies (BMF dated 10 May 2022).

In the case of capital income, a so-called “partial loan” will most likely be considered.

Since other income can only be assumed if no other type of income is relevant, priority must be given to capital income.

Entry and exit are generally not a tax-relevant fact

Deviating from the purely legal allocation of taxable events, another assessment standard, the so-called “economic perspective”, has been laid down in tax law. This states that in certain cases the facts must be judged more according to the financial result and less according to formal legal criteria.

However, a tax-relevant exchange process fails when it enters the liquidity pool due to a financial transfer process. Derived from the principles laid down by the Federal Fiscal Court for securities lending, the borrower must not only formally have a legal position under civil law.

On the other hand, price risks and price opportunities associated with the securities must also be transferred to the borrower (financial perspective). In most cases of liquidity extraction, the program (protocol) stipulates that these risks (eg price risks, permanent loss) are not passed but remain with the taxpayer.

The Federal Tax Court has also decided that it must be sufficient for the transfer of real ownership of shares that the lender has a notice period of 3 days, as the borrower also has the opportunity to make a profit during this period. This means, conversely, that if the notice period is less than 3 days, there is a lot to be said for not transferring real ownership to the borrower. In most protocols, the taxpayer can opt-out and end liquidity extraction at any time with the push of a button.

In this connection, it can be assumed that the principles for securities lending also apply here, and entry and exit therefore do not constitute a tax-relevant fact.

For the sake of completeness, it must be pointed out that at the time of withdrawal from the liquidity pool, the pool changes that have taken place in the meantime may result in a different composition of the trading pairs made available to the liquidity pool by the taxpayer in relation to quantity. This may result in other revenues from private sales transactions, especially assuming that crypto-to-crypto transactions are already taxable and the change in the performance requirement under the tax law does not first occur through “crypto to fiat transactions” (realization of ” payment”). A tax-relevant realization will therefore be able to take place at the earliest at the time of the actual withdrawal from the liquidity pool.


Authors Sven Kamchen and Oliver Christian Schroen specialize in crypto issues.

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