It can be confusing to navigate the tax landscape when it comes to DeFi in Canada. DeFi, short for decentralized finance, refers to a financial system built on blockchain technology that operates without intermediaries like banks. Instead, it uses smart contracts to facilitate transactions, including lending, borrowing, trading, and more.
With new innovations and platforms emerging, it's important for users to understand how the Canada Revenue Agency (CRA) taxes DeFi activities. Understanding DeFi tax in Canada will help users stay compliant and avoid any potential penalties.
From capital gains to income tax derived from DeFi activities such as trading, lending, and even gaming, this guide will cover all aspects of DeFi taxation in Canada.
Buying, Selling, and Trading on DEXs
Although there are more complex activities when it comes to DeFi, let's start with the basics - buying, selling, and trading on decentralized exchanges (DEXs). As a general rule, any gains or losses from these activities are considered capital gains for tax purposes. This means that when you sell your crypto for more than what you bought it for, you will have to pay taxes on the difference.
Now, when it comes to buying crypto, the currency you use matters. If you are using a fiat currency such as CAD, the Canadian Revenue Agency considers this as a tax free event. However, if you are using another cryptocurrency to make a purchase, this will trigger a taxable event and you will need to report any gains or losses on your taxes.
If your crypto activities resemble those of a day trader or other business-like operations, any profits earned from selling or trading crypto on DEXs may be subject to Income Tax instead.
There are several factors might suggest that you are operating a business such as Frequency of transactions (e.g., thousands annually).While no single factor may definitively classify your activities as a business, the combination of several factors could indicate otherwise. Determining whether you are carrying on a business depends on the specific circumstances of each case.
So, for example, if you earned $50,000 profits on trading cryptocurrencies, that would not be considered a capital gain, but rather a business income and would be taxed accordingly within the bracket of your personal income tax.
Taxation of Liquidity Pools and Liquidity Mining
In order for DeFi to work efficiently, liquidity must be provided in a decentralized manner. This is where liquidity pools and liquidity mining come into play. Liquidity pools are essentially a pool of funds that users can deposit their crypto assets into, which then provides liquidity for trading on DEXs. In return, users are rewarded with a share of the transaction fees generated by the pool.
These rewards are taxable. The income you earn from providing liquidity (regardless of the protocol), is perceived as a crypto-to-crypto trade under the Capital Gains Tax.
The basic inclusion rate for all capital gains and losses was increased from one half to two thirds as of June 25, 2024. Note that individuals are entitled to a reduction when calculating their total income that decreases the inclusion rate applied to their capital gains that are under a threshold amount of $250,000.
Although you may not be disposing of the original asset used to generate liquidity, it is still considered a taxable event and you will need to report any gains or losses on your taxes.
The CRA does not specify specific thresholds for taxation on types of rewards earned from providing liquidity in decentralized exchanges. Instead, they base the determination on behavioral patterns such as frequency and intention. So, make sure to define your intentions and record your activities accurately to ensure compliance with tax laws.
Yield Farming Tax
Yield farming involves various DeFi strategies aimed at maximizing profits by leveraging different protocols. However, the taxation of yield farming and other DeFi activities remains a developing area. The Canada Revenue Agency (CRA) has yet to issue explicit guidance for every aspect of DeFi, which means users must interpret existing tax rules and apply them accordingly. Some transactions may be classified as capital gains, while others may fall under income tax, depending on their nature and intent. Given this ambiguity, keeping detailed records and consulting a tax professional is crucial for compliance.
To yield farm, one interacts with smart contracts to earn additional tokens or interest on their crypto assets. For example, one can provide liquidity to a liquidity pool and then stake the resulting LP tokens in another protocol to earn additional rewards. The idea is to find the best yields, whether that involves providing liquidity, staking, or a combination of both that is above the interest rate of loaned capital, resulting in a profit.
When it comes to taxes, yield farming can be even more complex than liquidity providing, as there are multiple steps involved in the process and different types of rewards received. Depending on the specific strategies used, yield farming can result in capital gains or income tax events. It is important to keep track of all transactions and rewards received, as they will need to be reported on your taxes.
That said, if you earn new tokens, they may be considered income, requiring you to pay Income Tax based on their fair market value (FMV) at the time they were received. In other protocols, a 1:1 trade for a liquidity-specific token is made.
Determining FMV for newly received tokens:
For less liquid or newer tokens, FMV can be approximated by:
• Using the average market price from reputable exchanges.
• Comparing to similar tokens if no direct market data exists.
Tracking each transaction and reward is vital for accurate reporting.
When that token is sold at a higher value than it was acquired for, you have a capital gain and will need to pay Capital Gains Tax. If this protocol also pays out rewards as new tokens, these tokens are subject to Income Tax. So, multiple tax events can occur in more complex DeFi strategies, and it is important to keep track of each one.
DeFi Lending Tax
Earning new tokens is likely taxed as Income, while gains in token value are subject to Capital Gains Tax. Paying interest with crypto can be complex.
Let’s see tax obligations depend on your activities with examples:
• Earning rewards (e.g., tokens or interest): Taxable as income.
• Gains in token value: Subject to capital gains tax.
• Paying interest with crypto: Considered a disposal and potentially taxable under capital gains tax.
Deductible expenses: Interest payments may be deductible if the borrowed crypto is used for income-generating purposes. Consulting a tax professional ensures proper classification and deduction.
If you are unsure of the tax implications of your DeFi lending activities, it is always advisable to consult a tax professional. They can help guide you in understanding your tax obligations and ensure that you are properly reporting any income or gains from participating in DeFi lending pools. When it comes to more complex situations like these, accurate reporting and tracking will help you avoid any potential penalties or issues with the CRA.
Staking Taxes Reviewed
Although staking is often categorized under DeFi, its taxation differs from liquidity mining and yield farming. The key distinction lies in how rewards are generated. Staking rewards come from securing a network, whereas DeFi yield farming often involves complex financial mechanisms like borrowing, lending, or leveraging liquidity pools. Depending on the nature of your staking activities, CRA may classify staking rewards as income, similar to interest or dividends. However, certain protocols blur the lines between staking and yield farming, making it even more important to track and report transactions accurately.
Staking is a common activity within DeFi networks as rewards are given to those that pledge their crypto to secure a network. Many blockchains utilize validators to ensure no malicious activity is occurring on their network. These validators are typically rewarded with new tokens as an incentive to maintain network security.
In this case, rewards received from staking are considered Income Tax as many see it as similar to earning interest or dividends on traditional investments. Now, let's imagine that your staked crypto is worth $100 per coin and you staked one coin. If you earned 10% per year, by the end of the year, you would end up with $110 worth of the stacked coin.
This $10 gain would be subject to Income Tax and should be reported on your taxes. If your crypto token itself has increased by 100% to $200, and you sold the underlying crypto asset for a profit of $100, you would be liable for Capital Gains Tax on the $100 profit.
Taxation on Margin Trading, Derivatives, and Other CFDs
The tax treatment of crypto margin trading, derivatives, and other crypto CFDs—whether on centralized or decentralized exchanges—remains undefined. Ultimately, how these activities are taxed depends on whether you’re classified as a day trader running a business or an individual investor.
While there's no definitive criteria, some factors such as frequency of the trading, intent of trading could be the factor the CRA distinguish between those two.
As an individual investor, any profits you earn from closing a position are subject to Capital Gains Tax. Margin fees, if directly linked to your crypto trading activities, can be deducted for tax purposes. However, liquidations are treated as dispositions, meaning any resulting profit will also incur Capital Gains Tax.
If you’re classified as a day trader, any profits you make will be subject to Income Tax as soon as you close a position. You may be wondering what exactly does the CRA define as a day trader? Unfortunately, there is no defined criteria for this and it will depend on the individual's trading activity.
Play To Earn Taxes: Level Up Your Knowledge
Games are a natural part of society and so are taxes. When it comes to blockchain technology and gaming, more specifically Play-To-Earn games, there are some things to consider when it comes to taxes.
Play-To-Earn games are decentralized applications (DApps) that allow players to earn cryptocurrency by playing the game and completing tasks. The income earned from these games is considered taxable, just like any other form of income. However, the tax implications may differ depending on how you earn and use the cryptocurrency.
If you are earning cryptocurrency purely through gameplay and then holding onto it, it will be subject to Capital Gains Tax once you decide to sell or trade it. On the other hand, if you are earning cryptocurrency and using it to purchase in-game items or services within the same game, the tax implications may be different.
If you trade crypto earned from gaming for an NFT for example, that is considered a disposition of asset and capital gains tax may apply. Selling the Play-To-Earn token will also trigger capital gains tax.
Note that the CRA generally requires reporting “all” income, regardless of amount. While occasional, small earnings may seem negligible, they must still be reported.
NFT Taxes
The concept of NFTs is much more complex than the taxation of them. They are treated similarly to buying, selling and trading cryptocurrencies. Buying NFTs with fiat are not taxable. If you use crypto to buy NFTs, the gains or losses (compared to the original purchase price of that crypto) will need to be reported as capital gains. Trading NFTs depends on your acquisition price.
If you trade an NFT that you bought for $1000 for an NFT worth $2000 (at fair market value) and you made a profit, you need to report it on your taxes.
Now, if you created an NFT, and sold it for $1000, that's an income tax of $1000. But if you sell an NFT for crypto, the profit/losses need to be reported. This profit/loss would be calculated by comparing the acquisition price/sale price of the NFT in relation to the value of crypto at that time.
Gas Fee Taxes Explained
By now, you are probably realizing how many taxable events can occur that will eat away your profits but there are some deductions that can help offset those taxes. One of these deductions is the gas fees incurred when making transactions. One of these deductions is the gas fees incurred when making transactions.
Gas fees incurred during transactions can be tax-deductible, depending on their purpose:
• Asset Acquisition: Gas fees related to acquiring crypto assets can be added to the adjusted cost base (ACB) of the asset. For example, if you pay $10 in gas fees to purchase a cryptocurrency, this amount increases your purchase cost, reducing future capital gains when you sell.
• Trading Activity: Gas fees associated with crypto trading may be classified as separate expenses. For instance, if you pay gas fees to execute trades on a DEX, these fees could potentially be deducted as a cost of doing business if your trading activities are classified as business income.
Understanding the intention behind the gas fee and its link to the activity helps determine its tax treatment. Proper documentation is essential to ensure accurate reporting and to claim deductions appropriately.
Wrapped Tokens Tax
Wrapped tokens enable seamless interoperability between different blockchains, such as WETH or WBTC. Wrapping a token essentially means exchanging one token for its equivalent on another blockchain, functioning much like a crypto-to-crypto trade. This process may be subject to Capital Gains Tax, but since the two tokens hold equivalent value, it often results in no realized gain or loss.
This can be likened to trading a stablecoin for another stablecoin, both pegged to the USD. As both tokens hold the same value, there is no gain or loss in relation to USD. However, it is important to keep track of these transactions for tax purposes and report them accordingly.
The CRA’s stance on such transactions may evolve, so stay updated on guidance.
Token Rebases Tax
Certain tokens are designed to stay aligned with the value of an underlying asset. For instance, Lido’s stETH mirrors the value of ETH. To preserve this balance, these tokens incorporate a mechanism known as rebasing. Rebasing adjusts the token supply in response to changes in price, ensuring the value remains consistent.
For instance, if a token is designed to maintain a value of $100 but its price begins to rise above that level, the supply of tokens in circulation will increase. Conversely, if the price falls below $100, the circulating supply will decrease. In essence, rebases—particularly those occurring daily—can adjust the number of tokens you hold, leaving you with either more or fewer over time.
To imagine an analogy with TradFi through stock splits would be the best way to understand rebases. With stock splits, the number of shares you own increases, but the overall value remains the same. Because the value remains the same, it's likely that this event will not be taxed by the CRA, despite the increase in total tokens/shares of a blockchain network you own.
While similar to a stock split, the CRA may still consider these events taxable. Monitor CRA updates for clarification on this topic.
Summary
Navigating DeFi taxes in Canada can be overwhelming with so many taxable events, from liquidity mining and staking to Play-to-Earn gaming. The Canada Revenue Agency (CRA) requires accurate reporting of gains, losses, and income from DeFi activities, but keeping track of complex transactions manually can lead to errors and missed deductions.
Our crypto profit and loss management & calculation tool “cryptact” simplifies this process by automatically classifying DeFi transactions, tracking taxable events, and providing clear, accurate records to ensure compliance. Whether you're trading on DEXs, participating in yield farming, or engaging in Play-to-Earn games, our tool can help you manage your crypto taxes with ease and precision.
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