How Is Yield Farming Taxed?

Yield farming involves lending or staking cryptocurrencies to boost earnings or rewards. It is one of the key investment strategies in decentralized finance (DeFi) ecosystems and is the most significant growth driver in this sector.

Yield farmers are also called liquidity providers since they help the protocol by contributing liquidity in crypto pairs while earning rewards. These rewards come in the form of interest from lenders, transaction fee percentages, governance, or liquidity provider tokens.

Can Yield Farming Be Taxed?

Since the entire DeFi space is still nascent, many tax bodies haven't caught up to the tech, and therefore, there are no concrete guidelines for taxing earnings sourced from DeFi strategies like yield farming. However, depending on the investor's jurisdiction, the tax rules that govern crypto earnings may also be applicable to yield farming since profits earned from yield farming are usually in cryptocurrency.

The crypto tax rules include:

• Yield Farm Earnings as Income Tax: any income earned from crypto falls under the income tax rule. In yield farming, this will apply to activities like receiving rewards in crypto from staking or depositing crypto assets in a liquidity pool. As long as a yield farmer receives new tokens or coins, it will be subjected to income tax.
• Yield Farm Earnings as Captial Gains Tax: Countries that view cryptos as assets will tax yield farming earnings under the capital gains tax rule. Yield farming activities that will fall under this include:

1. Selling or swapping crypto rewards for fiat
2. Swapping crypto for crypto
3. Using yield profits to purchase a product or service
4. Giving out gifts in crypto

Yield farmers won't pay capital gains tax on their entire investment; instead, the tax is on the profits made from these transactions.

Do All Countries Have the Same Crypto Tax Rules?

While some countries are already on track to implement some semblance of tax rules on crypto assets, others seem unbothered. The details and complexity of the crypto tax code vary with different nations and depend on how the country's government views digital assets.

Nations that want to encourage crypto innovation may opt to place light taxes on digital assets. In contrast, those who don't care about crypto development may impose severe crypto taxes or outright ban cryptocurrencies.