Liquidity Provision Income

Liquidity provision income is generated when users deposit assets into a liquidity pool to facilitate trading on decentralized exchanges. This income is typically paid out as a share of the trading fees collected by the pool.

Like staking rewards, these payouts are generally viewed as taxable income upon receipt. The complexity arises because the composition of the liquidity position changes due to impermanent loss and the accumulation of different tokens.

Calculating the cost basis for these rewards requires tracking the value of each asset at the time of distribution. Investors must be prepared to report this as regular income and track the subsequent capital gains when those assets are sold.

This is a significant consideration for participants in decentralized finance.