Glossary

Liquidity pool

A liquidity pool is a smart contract holding paired tokens that traders swap against, and depositing tokens into one usually means exchanging them for a pool token, which the IRS may treat as a taxable disposition.

How it works

A liquidity pool holds paired tokens that traders swap against, and providers earn a share of fees and sometimes reward tokens. Depositing usually means exchanging your tokens for a pool token, which the IRS may treat as a taxable disposition; withdrawing is another exchange. Fees and rewards are income when received. Impermanent loss is not deductible until you withdraw at a loss.

Why it matters

A single position can generate dozens of taxable events, and the treatment of the deposit itself is a reportable position that should be consistent across years.

Related: DeFi, yield farming.

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Definitions are general information, not legal advice, and may not reflect the most recent changes in law.

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