Crypto DeFi and Tax: Don’t get Caught Out

Crypto DEFI networks _ tax

Decentralized Finance or DeFi holds the potential to disrupt and transform traditional financial systems — but DeFi investments aren’t exempt from taxation. Here’s how DeFi tax works in Australia.

So what about Crypto DeFi and Tax? DeFi, or decentralized finance, has rapidly grown from a relatively niche industry to a $40 billion ecosystem over the last year. DeFi seeks to decentralize traditional financial platforms and services, bringing them onto the blockchain and eliminating the need for third-party institutions or banks.

The DeFi ecosystem is now comprised of thousands of exchanges, lending platforms, liquidity pools, and decentralized savings account platforms that, in many cases, offer investors rates that exceed those available through traditional financial institutions.

While DeFi investments can be profitable, they’re not exempt from tax. How is DeFi treated from a tax perspective, though, and how does DeFi tax work?

What is DeFi?

    DeFi use cases include a variety of applications, which include:
  • Decentralized exchanges that allow users to trade cryptocurrencies without centralized exchange platforms
  • Prediction markets
  • Stablecoins that link the price of a digital asset to non-blockchain assets, such as fiat currencies
  • Lending platforms that provide users with interest for lending crypto or fiat to other users
  • Yield farming, which provides users with profit for lending crypto to liquidity providers

Both DeFi lending and DeFi yield farming platforms are the two most commonly used applications of DeFi, and are subject to the most confusion regarding tax treatment.

How Does DeFi Tax Work?

Australian tax treatment of yield farming or crypto lending in the DeFi ecosystem is complex. The Australian Taxation Office has not yet offered specific guidance regarding the tax implications of decentralized finance.

When assessing the potential of crypto DeFi and tax implications of DeFi in Australia, it’s best to refer to official ATO documentation regarding the tax treatment of cryptocurrencies. Notably, the ATO does not consider cryptocurrency a personal use asset if it is used in a profit-making scheme.

Specialist guidance published by ATO representatives within the ATO community platform indicates that the process of passing cryptocurrency to a third party as a disposal event. This applies to both crypto lending and staking cryptocurrency when cryptocurrency is transferred between wallets.

This means that lending or staking cryptocurrency in the DeFi ecosystem may trigger capital gains tax on any unrealized capital gains on the cryptocurrency transferred. This does not apply to cold staking in which the user retains full control over a wallet that holds crypto used in DeFi applications without the crypto changing ownership.

It’s also important to note that the ATO considers cryptocurrency returned to a DeFi user when a staking or lending period ends as a “new” asset — this returned cryptocurrency does not benefit from any 12-month capital gains tax that the original cryptocurrency investment may be eligible for.

Tax Treatment of Interest from DeFi

The ATO explicitly clarifies that any cryptocurrency earned from staking, lending, or other forms of interest that may be generated form DeFi applications is assessable as income.

So what do we know about crypto DeFi and tax? In simple terms, any profit in the form of interest or staking rewards in DeFi applications is considered as a form of ordinary income equivalent to the market value of the cryptocurrency at the time it is received, and is subject to income tax.

Key Takeaways

    While the Australian Taxation Office doesn’t provide guidance specifically for DeFi, the tax treatment of DeFi can be summarized as follows:
  • Transferring cryptocurrency between parties for DeFi applications is considered a taxable disposal event
  • Cryptocurrency returned after staking or lending — should it change ownership in the process — is considered a new asset and is only eligible for the 12 month CGT discounts 12 months after it is returned
  • Interest or rewards generated from DeFi lending or staking is subject to income tax

DeFi tax can be complicated. If you’re unsure of your tax obligations when investing or participating in DeFi, reach out to the crypto tax accountants at Fullstack for personalised tax guidance today.

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Stuart Reynolds is the founder of Fullstack Advisory, an award-winning accounting firm for businesses leading the future. He is a 3rd generation accountant who specialises in tech & online companies.

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