Concentrated Liquidity
Instead of spreading liquidity evenly across every possible price from zero to infinity, concentrated liquidity lets an LP pile capital into the narrow price range trading actually happens in, earning far more fees per dollar deposited.
Prerequisites: Impermanent Loss
A classic AMM pool spreads a liquidity provider's capital evenly across every price from zero to infinity, even though a stable pair like ETH/USDC might trade within a 10% band for months. Almost none of that deposited capital ever gets used, because the pool never trades anywhere near those extreme prices. Concentrated liquidity fixes this by letting an LP choose the specific price range their capital is active in, instead of the whole number line.
Concentrated liquidity lets an LP deposit capital into a chosen price range instead of the full 0-to-infinity range a classic AMM uses. The same dollar of capital earns far more fees while price stays inside the range — and earns zero once price exits it, because that capital simply isn't in play anymore.
Ranges instead of the whole curve
A classic pool's liquidity is spread thin across an infinite price axis; a concentrated position places liquidity only between a chosen lower and upper bound (often described using discrete price "ticks"). Within that range, the position behaves like a much deeper version of the classic formula, giving traders less slippage and the LP more fee income per dollar — but the moment price moves outside the chosen band, that position stops earning fees entirely and sits as 100% of whichever single token price exited toward, doing nothing until price re-enters the range or the LP manually adjusts it.
Worked example
An LP has $10,000 to deposit into ETH/USDC, currently trading at $3,000. Spread across the full price range, it earns fees at a baseline rate. Instead, they concentrate it into a $2,800–$3,200 band — a range roughly 13% wide around the current price.
- Capital efficiency. Uniswap v3's design means concentrating into a range this narrow can provide roughly the same depth (same fee-earning power at the current price) as spreading 4–10x as much capital across the full range, depending on how narrow the chosen band is — narrower bands multiply efficiency further, at the cost of a higher chance price exits the range.
- If ETH stays within $2,800–$3,200, this $10,000 earns fees as if it were several times that amount deposited in a classic pool.
- If ETH breaks above $3,200, the position is entirely converted to USDC and stops earning any fees at all until the LP either withdraws or manually resets the range to include the new price.
What this means in practice
Concentrated liquidity turned passive LPing into an active position-management problem much closer to running a market-making book with defined risk limits: an LP effectively places a bet on the trading range, gets paid handsomely for being right, and gets shut out of fee income (while also being maximally exposed to impermanent loss, since capital ends up entirely in one token) for being wrong. Professional LPs now run strategies that actively rebalance ranges as price moves, similar to how an options market maker manages a gamma position.
A narrow, highly efficient range isn't automatically a better choice than a wide one — it multiplies fee income while price stays inside the band, but it also multiplies the chance the position exits the range and goes fully inactive (and, once out, sits in whichever asset was depreciating, the worst possible side of impermanent loss). Choosing a range width is a real risk decision, not just a knob to maximize.
Further reading
- Adams et al., Uniswap v3 Core (whitepaper)
- Werner et al., ammMarket: A Survey of Automated Market Makers