Characterizing ancient clades of fungal symbionts is necessary for understanding the evolutionary process underlying symbiosis development. In this study, we investigated a distinct subgeneric taxon of Xylaria (Xylariaceae), named Pseudoxylaria, whose members have solely been isolated from the fungus garden of farming termites. Pseudoxylaria are inconspicuously present in active fungus gardens of termite colonies and only emerge in the form of vegetative stromata, when the fungus comb is no longer attended (“sit and wait” strategy). Insights into the genomic and metabolic consequences of their association, however, have remained sparse. Capitalizing on viable Pseudoxylaria cultures from different termite colonies, we obtained genomes of seven and transcriptomes of two Pseudoxylaria isolates. Using a whole-genome-based comparison with free-living members of the genus Xylaria, we document that the association has been accompanied by significant reductions in genome size, protein-coding gene content, and reduced functional capacities related to oxidative lignin degradation, oxidative stress responses and secondary metabolite production. Functional studies based on growth assays and fungus-fungus co-cultivations, coupled with isotope fractionation analysis, showed that Pseudoxylaria only moderately antagonizes growth of the termite food fungus Termitomyces, and instead extracts nutrients from the food fungus biomass for its own growth. We also uncovered that Pseudoxylaria is still capable of producing structurally unique metabolites, which was exemplified by the isolation of two novel metabolites, and that the natural product repertoire correlated with antimicrobial and insect antifeedant activity.