Concentrated Liquidity Mechanics

From Spread-Everywhere to Focused Liquidity

In the original automated market maker (AMM) design, liquidity providers (LPs) deposited two tokens and their capital was spread evenly across every possible price from zero to infinity. That's simple, but wildly inefficient: almost all trading happens within a narrow band of prices, so the vast majority of the deposited capital sat unused at prices that would essentially never occur. Concentrated liquidity, introduced by Uniswap v3, changed this by letting LPs choose a specific price range to provide liquidity in. Instead of spreading capital thin across all prices, an LP can concentrate it where trading actually happens — dramatically increasing how much of their money is doing useful work and earning fees.

Why Concentration Means Efficiency

By focusing capital in the active price range, an LP can provide the same depth of liquidity (the same ability to absorb trades without big price moves) using far less money than the old model required — or provide much deeper liquidity with the same money. This 'capital efficiency' is the whole point: the same dollar of liquidity earns more fees because it's concentrated where the trading volume is, rather than diluted across prices no one trades at. For traders, this can mean better prices and less slippage; for LPs, it can mean higher fee returns on their capital. Concentrated liquidity was a major leap in AMM design precisely because it attacked the enormous waste of the spread-everywhere approach.

• Original AMMs spread LP capital across all prices — mostly unused
• Concentrated liquidity (Uniswap v3) lets LPs pick a price range
• Focusing capital where trading happens hugely increases capital efficiency
• Same depth with less capital (or far deeper markets with the same capital)