Concentrated Liquidity pools are a type of liquidity pool found on decentralized exchanges (DEX) where you can set your own price range for liquidity allocation. This gives you complete control over the price range, and you can change it whenever you want. Compared to traditional ‘XYK’ liquidity pools, Concentrated Liquidity pools are more efficient with capital and can offer higher returns.
Why Use Concentrated Liquidity?
Concentrated Liquidity was introduced by Uniswap V3 in March 2021 to fix the issues with traditional XYK liquidity pools, where liquidity was spread out evenly from $0 to infinity.
This meant that while there was always liquidity available, a lot of it went unused. With Concentrated Liquidity, providers can now concentrate their funds in specific price ranges, making their capital work harder and potentially increasing their returns. This approach gives liquidity providers more flexibility and control over their investments, allowing for the possibility of higher, but fluctuating, yields based on their selected price ranges.
The Cons
It positions can be profitable, but they need more attention to manage and come with several risks to be aware of.
- Increased Oversight
- Potentially Higher Impermanent Loss
Conclusion
It is now the go-to choice for liquidity pools on popular DEXs like Uniswap, Ambient Finance, and Thruster Finance. While it can be a bit tricky to manage, its emphasis on capital efficiency marks a big step forward in DeFi, making it a strong contender for the future of the industry.