DeFi has exploded in popularity across the world, including Canada - but with great gains come great tax bills. That’s right, if you’re using dexes, DeFi lending protocols, liquidity mining, yield farming and more, the Canada Revenue Agency wants to know about it. You’ll need to report your DeFi activities as part of your annual Income Tax return. We’re looking at everything you need to know about Canada DeFi tax in our guide.
DeFi stands for decentralized finance. It’s an umbrella term for a huge variety of financial apps built using blockchain technology. We’ve got a great in-depth guide on all things DeFi already if you’d like to learn more, but in brief DeFi is looking to solve the many problems that traditional finance has.
It’s easiest to understand DeFi by looking at what it isn’t. Traditional finance is limited by markets, regulations, borders, internal policies and a select few corporations who decide who has access to finance and, conversely, who doesn’t.
DeFi on the other hand is decentralized and borderless. Anyone, anywhere can access the various financial apps without needing to provide extensive personal information, a credit score, proof of income and more. There are no centralized third parties taking their cut or limiting access - like a bank or a traditional crypto exchange.
So how does it all work if there’s no bank or third party?
By utilizing liquidity pools.
Almost all DeFi protocols rely on liquidity pools in order to function. This is where investors stake their assets in order to earn rewards in return. This liquidity is then used to finance the various transactions that may happen on the DeFi protocol - like trading, lending or more.
All transactions on a DeFi protocol are automated by smart contracts - pieces of digital code that set the terms of the transaction.
Smart contracts can be used to automate pretty much anything you can think of - provided you can code it. Let’s take a look at some of the most popular DeFi protocols and projects.
As we mentioned above, there are a huge variety of financial applications in the DeFi space, each with their own purpose. Some of the most popular DeFi protocols include:
With so many different kinds of DeFi protocols available, investors have a lot of new opportunities to earn through them. Some of the most common ways include:
As well as this, many investors seek out specific liquidity pools in order to earn specific tokens. For example, if you deposit liquidity to the new WETH.e pool on the Aave Avalanche, you’ll get WAVAX tokens, as well as fees, letting investors earn more. This is known as liquidity mining.
Yield farming is another term that’s sprung up out of the DeFi space and refers to the composability of protocols. In other words, the way different protocols work together, letting you earn on earnings. For example, if you provide liquidity on Curve, you get CRV tokens as your reward. You can then stake these CRV tokens in Convex Finance to earn rewards on your reward.
No matter how you’re earning through DeFi - one thing is sure. The CRA are going to want to know about it.
Let’s start with the obvious - the Canada Revenue Agency hasn’t issued any guidance on the tax treatment of DeFi yet.
That doesn’t mean you won’t pay tax on your DeFi transactions though. You need to look at the current guidance on crypto tax in Canada and infer how that would apply to your DeFi transactions.
We’ve got a great guide on Canada crypto tax for the full story, but in brief, crypto is either subject to Capital Gains Tax or Income Tax depending on the specific transaction.
Whenever you sell, trade, spend or gift crypto - you’ll pay Capital Gains Tax on any profit you make as a result of that transaction. However, if you’re seen to be trading as a business (like a day trader), you’ll actually pay Income Tax on this instead.
Whenever you’re seen to be making an income - like through mining, staking, bonuses or selling NFTs you create - you’ll pay Income Tax instead.
With all this in mind, to figure out Canada DeFi tax, we need to look at the specific transaction and how the CRA are likely to view it. So let’s break it down.
This one is nice and straightforward as there is clear guidance from the CRA. Provided you’re seen as an individual investor and not a business - you’ll pay Capital Gains Tax on any profits you make as a result of selling or trading crypto on dexes.
Buying crypto with fiat currency like CAD is tax free. Buying crypto with another cryptocurrency - even stablecoins - would be viewed as a trade and taxable transaction.
If you’re seen to be conducting business-like activities - like a day trader - you’ll pay Income Tax on any profits you make as a result of selling or trading crypto on dexes instead.
Liquidity pools all work in a similar way, no matter the specific protocol you’re using.
When you add liquidity to a given pool, you’ll get a liquidity pool token in return that represents your capital in the pool. When you want your capital back, you’ll trade your liquidity pool token back. For example, let’s say you added BUSD and BNB to a liquidity pool on PancakeSwap. You’d get a BUSD-BNB LP token in return.
Even though you’re not disposing of your asset - it’s likely this would be viewed as a crypto to crypto trade which is a taxable event under Capital Gains Tax. You’ll need to pay Capital Gains Tax on any profit from this transaction.
When it comes to the rewards you’re paid out from liquidity pools, it all depends on how you’re paid your rewards. Liquidity pools tend to work in one of two ways. Let’s look at two examples.
You’ve added BUSD and BNB on PancakeSwap and got your BUSD-BNB LP token(s) in return. You don’t earn new LP tokens on PancakeSwap whenever someone makes a transaction, instead the value of your liquidity pool token increases whenever someone makes a trade. It’s only when you remove your liquidity by trading your BUSD-BNB LP token(s) back that you’ll have a realized gain. In this example, you’d pay Capital Gains Tax on any profit at the point you realize your gain by removing your liquidity.
But not all liquidity pool rewards are paid out like this. Let’s say you deposit ETH to an Aave lending pool instead. You’ll get aTokens at a 1:1 ratio to represent your capital in the lending pool. However, your rewards are similarly paid out at a 1:1 ratio. This is far more likely to be seen as income because you’re earning new tokens. So while you may pay Capital Gains Tax on any profits when you trade your crypto for aTokens, it’s more likely the rewards you get as a result would be subject to Income Tax instead. You’d pay Income Tax based on the fair market value of your aTokens at the point you received them.
We’ve touched on this above with our Aave example, but it’s worth expanding on it as DeFi lending can get complicated from a tax perspective.
Though loaning your crypto or borrowing crypto doesn’t seem like a taxable event - because you often receive tokens in return to represent your asset or collateral, it may well be. This is easier to understand with an example.
Compound is a popular lending protocol. When you deposit an asset to loan, you add it to a lending pool (which is just another word for a liquidity pool). You’ll get cToken(s) in return representing your capital. When you want your capital back, you’ll trade your cToken(s back. This could be viewed as a crypto to crypto trade and therefore any profits subject to Capital Gains Tax.
Similarly, when you want to borrow crypto on Compound, you’ll need collateral. When you add collateral, you’ll get cToken(s) in return. When you’re done with your loan, you can remove your collateral by trading your cToken(s) back. These transactions are likely to be seen as a crypto to crypto trade which means any profits would be subject to Capital Gains Tax.
But what about interest?
Again, this all comes down to how your specific protocol works. In the Compound example, as you earn interest, the value of your cToken(s) increases the longer it’s in the lending pool. So in this instance, you don’t realize a gain until you remove your collateral. This is more likely to be seen as a Capital Gains Tax event as you’re not earning new coins.
However, when you lend or borrow on Compound, you’ll be rewarded with COMP tokens as a result. These are new tokens you can claim at any point. This would be viewed as additional income and you’d pay Income Tax based on the fair market value of your COMP tokens at the point you received them.
In short, earning new tokens is likely to be seen as Income and subject to Income Tax, while the value of tokens increasing is likely to be subject to Capital Gains Tax.
When it comes to paying interest - the tax implications are convoluted. Spending crypto is subject to Capital Gains Tax as it’s seen as a disposition. However, if you’re borrowing crypto to “buy income” - like investing in another DeFi platform that generates rewards - then interest paid may be deductible against that income.
Yield farming can refer to a huge variety of different activities - so it’ll all depend on how you’re being paid out. Let’s look at an example of SushiSwap yield farming.
You’ve added liquidity on SushiSwap and got SushiSwap LP tokens (SLP tokens) in return. You can then stake your SLP tokens to earn SUSHI tokens.
You can harvest these SUSHI token rewards at any point. You're earning new tokens, which would be seen as income and you'd need to pay Income Tax on the fair market value of your SUSHI tokens at the point you received them.
You can also then stake your SUSHI tokens to increase your rewards. However, when you stake SUSHI tokens, you'll get XSUSHI tokens in return. You don't earn new XSUSHI tokens, instead your XSUSHI tokens grow in value and you'll only realize your gain when you unstake your SUSHI tokens by trading your XSUSHI tokens back. This is more likely to be subject to Capital Gains Tax as you're trading crypto, not earning new tokens.
Overall, your yield farming will be subject to either Income Tax or Capital Gains Tax depending on whether you’re earning new tokens or your tokens are increasing in value.
Staking in the DeFi world can actually refer to two different transactions so let’s cover both.
Many investors use the phrase staking to refer to them adding an asset to a given protocol - like staking SLP tokens to earn Sushi. This could be subject to Income Tax if you’re earning new tokens, or Capital Gains Tax if the value of your tokens increases but you don’t receive new assets.
Staking is also used to refer to staking as part of a consensus mechanism. There are a number of Proof of Stake (PoS) blockchains in the DeFi space including ADA and AVAX. There are many non-custodial wallets you can use to stake as part of a PoS blockchain in order to earn rewards - for example, you can use Yoroi or Daedalus to stake ADA. As you’re earning new coins, this is likely to be seen as income and subject to Income Tax.
There’s no specific guidance on the tax treatment of crypto margin trading, crypto derivatives trading or other crypto CFDs for either centralized or decentralized exchanges.
But this will all come down to whether you’re seen to be acting as a day trader (like a business) or as an individual investor.
If you’re seen to be trading as an individual investor, you’ll pay Capital Gains Tax on any profits at the point you close a position. Margin fees are tax deductible provided they relate to your crypto trading, while liquidation is seen as a disposition and any profit subject to Capital Gains Tax.
Meanwhile, if you’re seen to be acting as a day trader, you’ll pay Income Tax on any profits at the point you close a position.
The CRA hasn’t issued any guidance on play-to-earn crypto gaming and tax just yet, but it’s all going to come down to how you earn and how your earnings are viewed.
If you’re earning minimal amounts (like hobby mining), it’s likely you’d only need to pay Capital Gains Tax when you later sold, traded, spent or gifted any coins/tokens you’ve earned through DeFi games.
If you’re earning larger amounts, regularly - like an income - you’re likely to pay Income Tax on your crypto, based on the fair market value at the point you receive it.
Of course, many DeFi games are using NFTs - so we’ll cover NFT taxes below.
Despite being non-fungible, these tokens are treated the same as any other cryptocurrency from a tax perspective. In short:
We’ve got a whole article on gas fees and taxes but in brief, transaction fees can be added to your cost basis and are therefore tax deductible while transfer fees likely cannot be added to your cost basis and should be treated as a disposition.
Wrapped tokens allow for interoperability between various blockchains - for example, WETH or WBTC.
When you ‘wrap’ a token, you’re exchanging one token for another. This could be seen as a crypto to crypto trade and subject to Capital Gains Tax. However, as the two tokens are of equivalent value, you’ll often have no realized gain or loss.
Some tokens need to maintain a consistent value with an underlying asset - for example, Lido’s stETH is tied to the value of ETH. To maintain this value, these tokens have what’s known as a rebasing function. Rebases adjust the supply of coins according to price fluctuations.
For example, if a token is supposed to be worth $1 but the price is rising above that, the number of coins in circulation would increase. Similarly, if the price dropped below $1, the number of coins in circulation would be reduced. In other words, you might end up with more or less tokens due to rebases - especially rebases that happen daily.
The CRA doesn’t have guidance on token rebases. However, we can liken these to a stock split, which they do have guidance on. The CRA states that stock splits are not seen as a disposition and therefore a non-taxable event. It would be reasonable to assume token rebases would be seen in a similar way.
Koinly crypto tax software calculates all your crypto taxes for you, including DeFi taxes. All you need to do is sync the wallets, exchanges or blockchains you use with Koinly through API or import a CSV file of your crypto transactions.
From here, Koinly will identify your different crypto transactions and apply the relevant taxes. Your data should be labeled automatically, but if it isn’t you can tag your DeFi transactions as a loan interest, received from pool or a reward for deposits. For withdrawals, you can tag your DeFi transactions as cost, interest payment or sent to pool.
We give you complete control over how conservative you’d like to be with your crypto tax reporting. In our settings, you can choose whether to realize gains on liquidity transactions, whether to treat other gains as capital gains and whether to treat transfer fees as disposals.
Once your transactions are imported, Koinly will calculate your crypto taxes for you. All you need to do is head over to the tax reports page, where you’ll see a simple summary of your crypto taxes. Below this, you’ll find a variety of tax reports you can download and submit to the CRA, as well as reports for specific tax apps like TurboTax and more.