Concentrated Liquidity

Concentrated liquidity is an automated market maker design that lets liquidity providers allocate their capital to a specific price range rather than spreading it across all possible prices. Within the chosen range, the provider's capital is used far more intensively, earning a larger share of trading fees per dollar deposited; outside the range, the position earns nothing and sits fully converted into one of the two assets.

Uniswap v3 introduced the model in 2021. A concrete example: instead of providing ETH/USDC liquidity across every price from zero to infinity, a provider concentrates their deposit between 1,800 and 2,200 USDC per ETH. While ETH trades inside that band, their capital behaves like a much larger conventional position, potentially earning multiples of the fees. If ETH rises above 2,200, the position has been entirely converted to USDC and stops earning until the price returns or the provider repositions.

A common misconception is that concentrated liquidity is simply better than the classic full-range model — the higher capital efficiency comes with amplified impermanent loss and a need for active management, since a range that the price exits earns nothing. It effectively turns liquidity provision from a passive deposit into an ongoing position-management job, which is why automated managers and vaults exist to rebalance ranges on providers' behalf. Stable pairs suit tight ranges; volatile pairs punish them.