๐งConcentrated Liquidity
Liquidity allocated within a custom price range
Last updated
Liquidity allocated within a custom price range
Last updated
ะกoncentrated liquidity โ is the liquidity allocated within a custom price range.
Concentrated Liquidity represents a groundbreaking liquidity solution that enables liquidity providers (LPs) to maximize their capital efficiency and mitigate impermanent loss by concentrating their liquidity within a specific price range. This innovative feature allows LPs to stake a specific token pair within a defined price range.
The APR is dependent on the TVL of the position, the amount of time that the position has been active, and the width of the range.
Earlier implementations of AMMs used the so-called XYK model, based on the x*y=k price curve. The idea was to maintain constant balance within a liquidity pool so that the total value of one token would always equal the total value of the other token in the pool; regardless of their current price against each other.
With the XYK model, the liquidity in the pool is spread across all possible price ranges. As a result, the liquidity providers (LPs) are earning far smaller trading fee bonuses โ which is their compensation for the risk they take. They also suffer from higher slippage, because the majority of their liquidity never gets used in pools of this type at all.
Concentrated liquidity tries to boost capital efficiency, and to make up for the inadequacy of the original formula. Within the new model, liquidity can be allocated to a price interval, resulting in what is called a concentrated liquidity position. LPs can open as many positions in the pool as they wish, thereby creating unique price curves aligned with their personal needs and preferences.
When the price enters a specific range, the liquidity aggregated for that range starts collecting trading fees, with each LP receiving their slice of the fee pie, proportionally to their contribution to the total liquidity inside of that price range alone.
As the price moves up and down, liquidity from different LPs is used to execute the swaps. Consequently, users are making trades against the aggregated liquidity from all liquidity positions covering the current price, and there is no difference for those whose liquidity their swaps are utilizing.
There are a number of benefits and advantages that the new model of pooling liquidity offers both LPs and traders. Now, LPs can allocate their capital to the preferred price intervals, consolidating their funds to earn more fees and using liquidity more efficiently. At the same time, traders enjoy deeper liquidity when and where itโs needed most, as well as profiting greatly from reduced slippage.
Norton and Solbytes are both interested in providing liquidity in an ETH/USDC pool on Synthswap v3, each with $1m. The current price of ETH is $1,597.
Norton chooses to distribute his capital across the entire price spectrum, depositing 500,000 USDC and 307.9 ETH, totaling $1m.
Solbytes decided to create a focused position, depositing only within the price range of $1,000 to $2,250. He deposits 66,750 USDC and 45.5 ETH, which amount to around $133,500. He invests the remaining $866,500 elsewhere.
Despite Norton contributing 7.5 times more capital than Solbytes, they earn the same amount of fees as long as the price of ETH/USDC stays within the $1,000 to $2,250 range.
We would like to take this opportunity to extend our gratitude to Algebra, our partner in bringing the Concentrated Liquidity feature to the Synthswap platform.
Without their support and expertise, the integration of this innovative liquidity solution would not have been possible. Algebraโs commitment to excellence and passion for driving innovation in the decentralized finance space has been instrumental in making this milestone achievement a reality. We look forward to continuing our partnership with Algebra, and together, we will work towards creating a brighter future for decentralized finance. Thank you, Algebra, for your invaluable contributions to our project.
