Understanding how concentrated liquidity works can provide higher returns, higher efficiencies, and DEEP liquidity. The concept of concentrated liquidity was popularized by@UniswapV3 in 2021. In traditional models, LPs are limited to supplying liquidity to the entire bonding curve, from a price range of 0-∞. This means that a majority of the supplied liquidity may never actually be used.
Concentrated Liquidity with Traditional Models
Concentrated liquidity allows liquidity providers to allocate capital to closed intervals of an asset's price range. Instead of supplying liquidity from 0-∞ you can instead concentrate your liquidity around the price where it is actually needed.
Concentrated Liquidity with Liquidity Book
Supplying liquidity to a selected price becomes possible by breaking the price range into discrete ranges.
The Liquidity Book using 'bins', with each bin representing a unique price.
Users are able to distribute liquidity however they like into each liquidity bin. There are endless ways to structure your liquidity depending on your goals. Check out Liquidity Strategies. Deploying liquidity to a concentrated range is significantly more capital-efficient. Traditional AMMs are very capital-heavy, requiring large amounts of TVL to facilitate swaps.
Increased capital efficiencies allow concentrated AMMs to facilitate higher volumes with far less TVL required. Increased capital efficiencies can also allow token pairs to:
• Provide deep token liquidity, with far less capital
• Provide liquidity with low-to-no need for incentives
• Have increased flexibility
• Gain higher real-yield rewards for LPs
For users swapping assets, concentrated liquidity can result in far less or even zero slippage.
Slippage is the difference between the quoted price and the executed price, and it can have a significant impact on your trades. For each swap executed on Swapline, a small swap fee is accumulated and distributed to liquidity providers.
This generates real yield for liquidity providers, paid in the same tokens you provided.
Swap rewards are only earnt by liquidity providers deposited at the currently active price. As the asset price moves out of your liquidity range, you will no longer earn any fees. Liquidity providers may consider changing their price range to continue earning fees.
A tightly concentrated price range can introduce higher risk. As token prices diverge from their prices at deposit, your liquidity changes in value when compared to its value if tokens were held outside the pool. Divergence loss can be amplified in concentrated liquidity pools.
Liquidity Book introduces variable fees that aim to compensate liquidity providers for impermanent loss (divergence loss).
During times of high volatility, variable fees are increased which can help mitigate the impacts of impermanent loss. In traditional AMMs users will be accustomed to providing liquidity to a 50:50 value ratio. In a concentrated liquidity AMM only one discretized range will contain both Token X & Y. This means when the price leaves your liquidity range you will be left holding only 1 token type
Liquidity Providers Token Holdings with Liquidity Book
Concentrated liquidity is a little bit more challenging for liquidity providers and protocols.