What is Concentrated Liquidity? | Delphi Digital (2024)

FAQs

What is Concentrated Liquidity? | Delphi Digital? ›

With concentrated liquidity, you're compressing the X*Y=K price curve between a pre-determined floor and ceiling. The upside of this is that all your capital is being put to good use if the price is within your range. The downside is that impermanent loss is magnified.

Concentrated liquidity represents a significant evolution in the field of decentralized finance (DeFi) and liquidity provision. This concept allows liquidity providers (LPs) to allocate their capital to specific price ranges within a liquidity pool, rather than across the entire price curve.

Concentrated liquidity​

Uniswap V3 Pools use concentrated liquidity to allow a denser concentration of liquidity at specific prices. Compared to the full range liquidity model Uniswap V2 uses, this allows traders to make larger trades with less price impact.

What is a CLMM? Concentrated Liquidity Market Maker (CLMM) pools allow liquidity providers to select a specific price range at which liquidity is active for trades within a pool. This is in contrast to constant product Automated Market Maker (AMM) pools, where all liquidity is spread out on a price curve from 0 to ∞.

Concentrated liquidity reduces slippage for traders. Since more liquidity is available within the active trading ranges, trades can be executed with less price impact, resulting in better prices for traders.

Liquidity refers to the ease with which an asset, or security, can be converted into ready cash without affecting its market price. Cash is the most liquid of assets, while tangible items are less liquid. The two main types of liquidity are market liquidity and accounting liquidity.

Liquidity is neither good nor bad. Everyone should have liquid assets in their portfolio. However, being all liquid or all illiquid can be risky. Instead, it's better to balance assets with your investment goals and risk tolerance to include both liquid and illiquid assets.

The prevailing strategy with concentrated liquidity is to keep the range tight to maximize fees and actively manage it. This takes a ton of effort, forces us to realize a lot of impermanent loss, and has led to a majority of liquidity providers losing money.

The standard solutiondefinition is: a solution that has a precisely known concentration of an element or compound. A standard solution in chemistry is one that has a known concentration of a certain chemical or analyte.

Another major risk involves the concentration of large deposits in AMM pools. High concentrations of 'whales' can lead to significant risky situations where the pricing dynamics of a pool could change substantially if a large depositor withdraws their assets.

What are the risks of concentrated liquidity? ›

To achieve concentrated liquidity, the once continuous spectrum of price space has been partitioned with ticks. Ticks are the boundaries between discrete areas in price space. Ticks are spaced such that an increase or decrease of 1 tick represents a 0.01% increase or decrease in price at any point in price space.

The impermanent loss is the possible loss from liquidity provision, compared to the static strategy where the liquidity provider holds the corresponding tokens in the pool unchanged. Due to the change of token pool price, once the provider closes her position and exits the pool, the impermanent loss would be realized.

When there is a high demand for an asset, there is high liquidity, as it will be easier to find a buyer (or seller) for that asset. Cash is considered the most liquid asset because it is very stable, can be readily accessed and easily spent.