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Concentrated Liquidity

Concentrated liquidity refers to the ability for liquidity providers (LPs) to select a particular range along the price curve to provide liquidity.

Written by Yenwen Feng, co-founder of Perpetual Protocol.
Yenwen Feng is a cryptocurrency and technology professional with vast experience as a CEO and co-founder of several startups. Since 2004, Yenwen founded Decore (Stripe Atlas fMessengeror Crypto Companies), Cinch Network (Decentralized Derivatives), Cubie Messenger (Mobile , 500 Startups B5, 10M downloads), Gamelet, and Willmobile (Top mobile financial service app in Taiwan, acquired by Systex). Since 2019, Yenwen is co-founder of Perpetual Protocol.

First introduced by Uniswap v3, concentrated liquidity aims to boost capital efficiency, and to make up for the inadequacy of the original x*y = k formula underlying the standard automated market maker model. 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 view of the market using what are known as range orders. 

Concentrating liquidity around the current price, as well as updating custom positions according to the price changes, is an effective strategy that is aimed at maximizing gains while exposing far less capital to the risk of asset devaluation. The tighter the range that is set for a concentrated liquidity position, the greater fee revenue you will earn, and vice versa. LPs can still select to provide liquidity across the entire curve, but they will not earn as much trading fees as compared to selecting a smaller range of prices.

As the price fluctuates, 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 it makes no difference to takers whose liquidity their swaps are consuming.