Before we get into it, we want to warn you that Awaken isn't perfect out-of-the-box for liquidity providing (yet). It's very complicated to track P&L and impermanent loss for liquidity positions, and on top of that protocols implement liquidity providing differently. This presents a challenge for Awaken and other softwares, but we are determined to improve our support and make a better experience for you.

If you have issues, email team@awaken.tax (or message us via the chat widget in the bottom right). With that being said, let's jump in!

Up until a few years ago, the main way to liquidity provide was to deposit 2 tokens and get a new LP token to represent your position. This would be something like "UNI-V2", and represent your LP position. Then when you claim fees on the position, each of those claims would be income. And you swap into the protocol to get your initial tokens out (with potentially impermanent loss being represented by a capital gain/loss).

To label it this way, we have the "Add Liquidity Swap", and when you remove it can be labeled "Remove Liquidity Swap". So anytime you swap two tokens for 1 LP token, or 1 LP token for 2 original tokens. The top two labels are your go to.

With UNI-V3, a new paradigm emerged for liquidity providing where you simply deposited tokens into an LP protocol (and sometimes got an NFT representing your position). These NFTs are not useful for tax purposes (you cannot attribute a cost basis to them) because users can add and remove from them at will.

What is important is tracking tokens that are deposited and withdraw from the protocol. And attributing income when you either claim fees or withdraw them at the end. This is very tricky to track (and because each protocol implements it differently, that compounds the difficulty).

There are a variety of protocols who implement liquidity providing this way including:

This is becoming the most popular way to liquidity provide. And like we said above, it is hard to track taxwise.

A few examples of what transactions look like:

To handle this properly, if they are not automatically labeled for you, you'll want to label these transactions as "Deposit Liquidity" (if you are sending tokens) and "Withdraw Liquidity" (if you are receiving tokens). Note: this has a similar tax impact to you staking and unstaking your tokens, where you cost basis is carried over on the unstake. So if you have $1,000 cost basis of ETH tokens you deposit into an LP pool this way, when you withdraw those tokens will keep your $1,000 cost basis.

If your income looks too high on the withdrawals, we usually add a little "Edit Income" button where you can override the income. You may want to pull up the liquidity P&L in the LP website (ex. Meteroa) and match it with our numbers (and adjust as needed). This way you don't realize too much income in the cases where it's difficult for us to track it.

For any transactions where you are claiming liquidity providing fees, you can label it as "Claim rewards" that way it is attributed to your income.

In some cases if you are receiving an NFT for a position we don't have automated support for, you may want to hide that transfer (by hovering over the "More" and clicking delete). These NFT's aren't useful and throw off the actual LP positions being tracked. For tax purpose they are not useful.

At the end of the day, you want to make sure the numbers in Awaken match as closely as possible the P&L you see on the website you use for liquidity providing. It may take a little bit of manual labeling (every year we improve this more and more though, so give us all your hard feedback because we write it all down.

We hope this article is helpful. If you have questions or ideas on how we can make it better, send us a message. We are always looking to improve :). Thanks!