Concentrated Liquidity

In a standard liquidity pool, the money deposited by liquidity providers is spread evenly across all possible prices — from zero to infinity. Most of that money sits idle at price ranges where trading almost never happens. Concentrated liquidity is a design improvement that allows liquidity providers to specify a particular price range where they want their funds to be active. All of their deposited capital works only within that range, which means it is far more efficient and earns more fees per dollar when trades occur there.

Think of it as the difference between covering an entire football field with a thin layer of water versus pouring all that water into a small bucket. The bucket is much more useful for the specific task of filling a cup. When trading happens within the range you chose, your liquidity is doing real work and you earn a proportionally larger share of the trading fees. If the price moves outside your chosen range, your liquidity temporarily stops earning and your position becomes entirely one of the two tokens.

Concentrated liquidity was introduced by Uniswap V3 and represents a significant leap in capital efficiency for decentralized trading. It also introduces more complexity for providers, who must actively manage their price ranges to stay relevant as markets move. This has given rise to automated liquidity managers — separate protocols that handle range management on behalf of passive depositors.

Example: Suppose you are renting out parking spaces near a stadium. You could spread your spaces across 50 different cities hoping for events, or you could concentrate all your spaces in the one city where the team actually plays. You earn far more when games happen, but you earn nothing if the team moves to a different city.