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Concentrated Liquidity

Uniswap v3 introduced range-bound concentrated liquidity. This DEX design allows LPs to decide the limits between which they would like to provide liquidity. In a conventional Uniswap v2 pool, your liquidity is distributed across the entire price curve between 0 and infinity. On Uniswap v3 you can choose to provide your liquidity between a defined range, say for ETH $1400-1900 – where most demand lies. These two values are your LP position’s floor and ceiling respectively.

The curve for concentrated liquidity positions is essentially still an X*Y=K curve, but the action of choosing a floor and ceiling for your liquidity provision makes this a lot more capital efficient. 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. A recent study showed the majority of Uniswap v3 liquidity providers lost more than they gained.

docs.uniswap.org

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