MSTR Cat

Crypto Law/Level II · Tax: the first trap/2.2 Income from crypto/Lesson 6

Liquidity pools and LP tokens

What happens, for tax purposes, when you deposit two tokens into a trading pool, earn a share of its fees and later withdraw a different mix, and why the records fall on you.

Education, not legal, tax or investment advice. Crypto law differs between countries and states and changes often. Check the current rules where you live with a qualified lawyer or tax adviser before you act.

The lean path

The cheapest, lowest-tax, simplest and most private route the law allows, best first. Each step names the rule it rests on and the condition that keeps it lawful.

  1. No IRS ruling decides whether a pool deposit is a taxable exchange; the reasonable non-disposal view defers gain, but apply it consistently and consider Form 8275 disclosure to limit section 6662 accuracy penalties.
  2. Fees compounding inside a version 2 pool reach you only at withdrawal, which some treat as part of the withdrawal rather than separate income; version 3 and 4 fee claims look more like income when collected.
  3. Hold withdrawn tokens more than a year before selling to reach long-term rates; for 2026 the 0% band runs to $49,450 of taxable income for single filers and $98,900 joint.
  4. No Form 1099-DA covers pool activity (Notice 2024-57; Pub. L. 119-5), so save each deposit, claim and withdrawal hash yourself; impermanent loss is not deductible, and full tax reporting still applies.

MaterialsIRS Notice 2024-57, section 3.03, on liquidity provider transactionsThe fee documentation of the pool you use (for example the Uniswap developer docs on fees)A block explorer record of your deposit, any fee claims and your withdrawal, with transaction hashes

Wonder

  1. Is putting my tokens into a liquidity pool a sale of them?
  2. When are the trading fees I earn taxed?
  3. Can I deduct impermanent loss?

Explore

  1. A liquidity pool is a smart contract holding two or more tokens that traders swap against; the contract sets prices by formula instead of matching buyers and sellers, which is why it is called an automated market maker. Liquidity providers deposit the tokens and usually receive an LP token, a receipt representing their share of the pool. Fees reward them. In Uniswap version 2, every pool charges 0.30% per swap, added automatically to the pool’s reserves; since a governance vote in December 2025, 0.05% of that goes to the protocol on v2 pools. In versions 3 and 4, fees accrue as balances that the position owner must collect.
  2. The US tax treatment of the deposit is not settled. One view is that handing over two tokens for a new LP token is an exchange of property, so gain or loss is realised on each token deposited, as with any swap (lesson 2.1.3). Another view is that nothing has been disposed of, because the depositor keeps a proportional economic interest in the same tokens. The IRS has not ruled. Notice 2024-57 lists both the deposit for an LP token and its redemption among transactions brokers need not report from 1 January 2025, and states that no inference is intended about their tax treatment.
  3. Fee mechanics affect timing. In a version 2 style pool, fees compound inside the pool and reach the provider only through a larger share of the reserves at withdrawal, which is one reason some treat them as part of the withdrawal rather than as separate income. In version 3 and 4 positions, fees are claimed separately, and some treat each claim as a receipt of income at its dollar value under the general section 61 principle (lesson 2.2.5). A position in version 3 or 4 earns fees only while the price is inside the range the provider chose. No published IRS guidance addresses either design specifically.
  4. Withdrawal means redeeming the LP token for a proportional share of whatever the pool then holds. Because traders have swapped against it, the mix returned usually differs from the mix deposited. Impermanent loss is the name for the shortfall compared with simply holding the original tokens. It is an economic measure, not a tax deduction. Tax is computed on actual events: if the deposit was treated as an exchange, the withdrawal is a second exchange of the LP token for tokens; if not, the gain or loss on the tokens is measured when they are later sold. Either way, basis records drive the result (lesson 2.3.1).
  5. Reporting will not do the work for you. In December 2024 the IRS published rules requiring certain DeFi front-ends to report as brokers, but Congress disapproved them under the Congressional Review Act; Public Law 119-5, signed on 10 April 2025, states that the rule has no force or effect. Form 1099-DA reporting covers brokers such as exchanges (lesson 2.3.5), and even there Notice 2024-57 excludes liquidity provider transactions. For most pool activity the only record is the blockchain itself, which shows every deposit, claim and withdrawal by transaction hash.
  6. The United Kingdom is also considering change. In its summary of responses published on 26 November 2025, the UK government said a possible no-gain, no-loss approach for transfers without an economic disposal would take liquidity pools, including automated market makers, into account; it described this as a potential approach still under assessment, not law. A practical check for any jurisdiction: for each pool position, record the deposit transaction, the tokens and amounts put in, the LP tokens received, any fees claimed and the withdrawal, then note which treatment you applied. This explains the law and does not give tax advice.

Key facts

  • The IRS has not issued a ruling on whether depositing tokens into a liquidity pool in exchange for an LP token is a taxable exchange.
  • Notice 2024-57 relieves brokers from reporting liquidity provider deposits and redemptions occurring on or after 1 January 2025.
  • Every Uniswap version 2 pool charges a 0.30% swap fee that is added to the pool’s reserves.
  • Impermanent loss is an economic comparison with holding the original tokens, not a separate deduction under US tax law.
  • Public Law 119-5, approved on 10 April 2025, disapproved the IRS rule on gross proceeds reporting by DeFi brokers and gave it no force or effect.
  • In November 2025 the UK government said it was still assessing a possible no-gain, no-loss approach covering liquidity pools.

Exercise nine, six, three, one

9CollectList up to 9 steps in the life of a liquidity pool position you hold or have studied, such as approving tokens, depositing, receiving LP tokens, claiming fees, rebalancing and withdrawing.
6ClusterSort them into 6 categories: deposits, receipt of LP tokens, fee accruals, fee claims, withdrawals, and steps with no clear tax treatment.
3DistillReduce the 6 categories to 3 groups: possible disposals, possible income, and record-keeping only.
1CrystallizeWrite 1 sentence explaining why impermanent loss and a tax loss are not the same thing.

Fact check

Dates, figures and claims checked against the published sources listed below.

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