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How Does Uniswap Taxes Work?

How Does Uniswap Taxes Work?

Uniswap was one of the first and most popular decentralized exchanges launched on the Ethereum network and quickly became a favorite, inspiring a variety of other competitors. Now in V3 (version 3), with a daily trading volume of $7 billion, Uniswap allows you to buy, sell, and trade ERC20 tokens and offers capital-free arbitrage opportunities through trading fast. But as with all cryptocurrencies, the IRS wants to know what you do on the platform. Here is all you need to know about Uniswap, its workings, and taxes.

What is Uniswap?

Uniswap is an Ethereum-based index that allows cryptocurrency investors to trade ERC20 tokens without a centralized third-party exchange, such as Binance, Kucoin, or Coinbase.

In general, centralized exchanges (and in some instances, some decentralized exchanges) are designed to make money by charging commissions. Uniswap seeks to do the opposite and serve a public good in the crypto space, allowing investors to trade tokens without a platform or third-party fees.

It uses a pricing mechanism known as the Constant Commodity Market Creation Model. This mechanism makes Uniswap work the way it does.

How does Uniwap work?

Anyone can add a token to Uniswap. All they have to do is launch a new Uniswap smart contract by creating a pool of liquidity and funding it with tokens and the value of the tokens in another cryptocurrency. For example, $20 in ETH and $20 in example coin.

Instead of combining buyers and sellers to trade these tokens and determine the price of a token, Uniswap uses a constant equation: x*y=k

X and Y are the values of two tokens in a given liquidity fund, while K is the constant value. This equation uses supply and demand to determine the price of a particular token. Suppose someone buys a sample coin with ETH in their liquidity fund, the supply of sample coins decreases, and the price increases. Meanwhile, if someone sells sample coins for ETH, the supply of sample coins increases, and prices fall.

Based on this equation, the more liquidity there is in a pool, the less price slippage when trading.

Uniswap Tax

Most tax offices around the world have yet to process the DeFi revolution. They have not released clear tax guidelines for popular DeFi platforms like Uniswap.

That being said, there are many guidelines regarding tax on cryptocurrencies in general. We just need to interpret the current cryptocurrency taxation rules and apply them to DeFi.

Do you pay taxes on Uniswap?

Yes. You will have to pay fees for your Uniswap trades and transactions.

Cryptocurrencies are subject to income tax or capital gains tax. The taxes you pay will depend on the specific transaction you are making, so let's look at each one.

Do you charge fees for Uniswap transactions?

Yes. Changing from one coin to another is subject to capital gains tax in most countries, especially the United States.

For example, if you trade UNI with ETH, you will pay taxes for any gains made with UNI. This is the difference in value between when you received UNI and when you changed it.

Do you pay taxes to add and remove liquidity on Uniswap?

As I said earlier, the IRS and many other tax offices have yet to issue clear guidelines.

You will receive a pool of liquidity tokens in return when you add and remove liquidity from a pool on Uniswap.

It may be considered a cryptocurrency transaction and subject to capital gains tax.

Generally, this is a crypto transaction, and the IRS can claim to treat these transactions as taxable events and subject cash transfers to capital gains tax.

Do you pay taxes on liquidity tokens on Uniswap?

It depends on the specific dex you're using. 

You do not earn new liquidity tokens on Uniswap. Instead, the token value of your cash fund increases based on the commissions made on a pool to which you have added capital. Therefore, you are not earning new tokens compared to when you are staking or mining. For this reason, your liquidity pool tokens are unlikely to be subject to income tax.

You will make a profit only when you want to withdraw your capital from a liquidity fund by trading your liquidity fund tokens. This transaction may be considered cryptocurrency and subject to capital gains tax.

Do you pay taxes on flash swaps on Uniswap?

Flash swaps work like any other trade, even if you don't initially provide the capital. Once the transaction is complete, you will exchange one token for another, and then you will have to pay capital gains tax on any resulting income.

Do you pay taxes to stake on UNI tokens and Uniswap liquidity tokens?

Yes. But it depends on where you live and how the specific DeFi protocol you're using works in terms of what kind of taxes you'll pay for staking.

Suppose you are staking on Uniswap UNI Token or LP Token and receive new tokens. As a result, you may have to pay income tax based on the fair market value of the new tokens when you receive them.

If you use a DeFi protocol where returns are paid in a lump sum when you remove your staked UNI or LP tokens, then you are most likely subject to capital gains tax.

What do I need to report to the IRS?

In the United States, you must report all taxable cryptocurrency transactions on Form 8949, which includes:

  • A description of the asset.

  • Date of disposal of the asset.

  • The cost basis of the asset at its fair market value.

  • The date you acquired the asset(s).

  • The sale price is at fair market value.

  • Your capital gain or loss.

You will also need to report the net gain and loss on Schedule D and any cryptocurrency on Schedule 1 and possibly Schedule C.

It's a lot of work. If you are an active trader or arbitrageur on Uniswap and other DeFi platforms, the list of trades you need to report can quickly grow into thousands per fiscal year. You will need good records of all your Uniswap transactions with all information; you can do it manually or with the help of a cryptocurrency tax lawyer. 

How to Find Uniswap Transaction History

To get started with Uniswap taxes, you need a complete history of Uniswap transactions. There are two ways to do this.

1. Use cryptocurrency loading software and connect to Ethereum blockchain via API. You can take your public address or ETH key from the wallet you use to interact with Uniswap and enter it directly into a cryptocurrency app that will automatically import Uniswap transaction history into your app and identify your taxable transactions, calculate the capital gains and losses, and income.

2. Export your Uniswap transaction history to a CSV file. You cannot download a CSV file directly from the Uniswap platform, but you can export a CSV file with your transaction history from your wallet, for example, Coinbase Wallet. You can also use a third-party service, such as Etherscan to get a CSV file with Uniswap transaction history. You can use this CSV file to identify taxable transactions, capital gains, losses, and incomes.

Does Uniswap report to the IRS?

Anonymity is a fundamental principle of the DeFi market. Trading is done directly from the chosen wallet, so no KYC verification is required to use Uniswap.

Most Web3 wallets, except Binance and Coinbase wallets, do not require KYC, but some require debit or credit card login. If you have funds coming out of your bank account or cashback, the IRS will want to know why. Also, if you move Uniswap tokens to centralized exchanges, many of those exchanges have come under pressure from the IRS to share KYC data.

Uniswap has not announced if it has come under pressure from the IRS to change KYC processes, but with new cryptocurrency legislation emerging, there is a good chance it might happen soon.



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