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How is Liquidity Mining (DeFi) taxed in Germany?

What is Decentralized Finance (DeFi)?

Parallel to the ever-increasing interest in cryptocurrencies among the general public, decentralized financial markets (DeFi) are becoming more popular. The DeFi boom has resulted from the popularity of liquidity mining.

DeFi represents novel alternatives to traditional financial markets. Whereas traditional financial sectors require a central actor (e.g. a bank or stock exchange) to regulate and control all transactions and services, in DeFi, this function is performed by a decentralized autonomous organization. This is an organization based on blockchain technology and makes use of so-called smart contracts (computer codes that can automatically execute certain specified rules) to independently manage transactions in the virtual financial market. Ideally, this represents a tamper-proof and transparent financial system.

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How does liquidity mining work?

One way for investors to make a profit on the decentralized exchanges (DEXs) is through so-called liquidity mining. This refers to a mechanism whereby investors invest their cryptocurrenciesin a pool and make it available to a decentralized exchange (DEX). Providers are rewarded for providing cryptocurrencies by, for example, being paid a portion of the fees incurred on the marketplace through transactions. In addition, governance tokens from various platforms can, nevertheless, also be distributed as rewards. Governance tokens grant holders participation rights within a DeFi platform (e.g. voting rights on the future development of the platform). These rewards, in turn, can be used to earn further profits on various DeFi platforms. Currently, many different DeFi platforms exist for liquidity mining, such as Uniswap, Synthetix, Nexus Mutual or Compound.

Liquidity mining in the example of Uniswap

Users of the DeFi platform Uniswap provide trading pairs in the form of different cryptocurrencies to the liquidity pool (e.g. ETH/USDC, ETH/DAI, ETH/wBTC). Each time liquidity is paid into a pool, governance tokens (UNI tokens) are distributed to the provider in proportion to the amount of liquidity contributed to the pool. In addition, fees are charged by the platform for each trade; these are distributed proportionately to all liquidity providers. The user can eventually claim the fees when he/she withdraws his trading pairs from the pool.

Three relevant times for taxation of liquidity mining in Germany

A total of three points in time are relevant for the fiscal assessment with respect to liquidity mining in Germany.

1. Dedication of the tokens

First of all, the dedication of the trading pairs within the pool is decisive for taxation. Adding trading pairs to a liquidity pool constitutes a sale of the pair for tax purposes. This results in a sale within the meaning of § 23 (1) Clause 1 No. 2 of the German Income Tax Act (EStG). Profits are taxable in this case if the sale of the trading pairs is within the speculation period of one year. However, if you have already held the cryptocurrencies for more than one year, the profits are tax-free in Germany.

2. Participation in the distribution of profits

The profit distributions during the period of participation in the pool are also relevant for the fiscal assessment. With regard to the fiscal assessment, there are different legal opinions. Due to the novelty of liquidity mining, there is neither a clarifying case law nor a statement from the German Federal Ministry of Finance (BMF) at this time. As a result, however, the profits from participation in the liquidity pool will nevertheless have to be treated as capital income and will therefore be subject to capital gains tax.

3. Withdrawal from the pool

Finally, the consequence of leaving the pool is that the user regains the trading pairs he/she contributed. The re-purchase of the trading pairs can occur here to varying degrees compared with the time of the token surrender. The holding period for the recovered cryptocurrencies starts at zero after obtaining the coins. Profits are also subject to capital gains tax in this case.

Your experts for the taxation of Liquidity Mining (DeFi) in Germany

We support crypto investors in determining profits from liquidity mining in connection with relevant software, such as Accointing, and take over the representation of interests vis-à-vis the tax office with regard to the classification as capital income. Your contact persons are

Benefit from our many years of experience in the taxation of cryptocurrencies. Contact us at +49 69 76 75 77 80, via email (info@winheller.com) or via our contact form for the taxation of cryptocurrencies.

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