What is Concentrated Liquidity?
Concentrated liquidity AMMs (CLMMs) now feature prominently across decentralized exchanges. Learn about how concentrated liquidity works, the risks, and popular CLMMs across blockchains.
What is concentrated liquidity?
Concentrated liquidity is a way of providing liquidity to a crypto trading pool where liquidity providers (LPs) choose the exact price range where their funds are active.
Instead of spreading liquidity across every possible price, LPs can “concentrate” their capital in a specific range where they think most trading will happen.
The concept was introduced by Uniswap v3, launched in 2021 by the Uniswap team led by Hayden Adams. It was designed to make decentralized exchanges (DEXs) far more capital-efficient than earlier automated market makers (AMMs).
Before concentrated liquidity, most AMMs worked with a simple rule: if you provided liquidity to a pool, your funds were spread across the entire price curve from zero to infinity. In practice, most of that liquidity was never used.
Concentrated liquidity fixes that.
Example
Imagine you’re running a currency exchange booth at an airport. Instead of offering exchange rates for every possible price of USD to EUR, you decide to only offer trades between $1.05 and $1.15, because that’s where the market usually sits.
Within that range, your booth becomes extremely competitive because you’re offering a lot of liquidity exactly where traders need it.
That’s essentially what concentrated liquidity does for decentralized exchanges. Liquidity providers choose the price band where their capital works, which allows the same amount of money to support much more trading activity.
The result is tighter spreads, better pricing for traders, and higher potential fee earnings for liquidity providers.
How does concentrated liquidity work?
Concentrated liquidity is still built on the same automated market maker principles that power most decentralized exchanges. The difference is how liquidity is distributed across prices.
Instead of being evenly distributed along the entire price curve, liquidity is placed into specific ranges. When the market price moves inside that range, the liquidity becomes active and facilitates trades.
If the price moves outside the chosen range, the liquidity effectively goes inactive until the price returns.
This system introduces several important technical concepts that help manage liquidity placement and trading.
What are trading bins?
Trading bins (sometimes called price ticks or liquidity bins, depending on the protocol) are discrete price ranges where liquidity is stored. Think of them as small containers along the price curve.
Each bin represents a narrow price band, and liquidity providers can deposit funds into one or multiple bins. For example, a pool might divide prices like this:
Bin 1: $1,800–$1,820
Bin 2: $1,820–$1,840
Bin 3: $1,840–$1,860
When trades occur and the market price moves, the active bin shifts.
As long as the price stays within a bin containing liquidity, trades can execute normally. If the price moves to the next bin, the protocol begins using the liquidity stored there instead.
Different protocols implement bins slightly differently:
Some use fixed price ticks (like Uniswap v3).
Others use bin-based AMMs where liquidity is stored in distinct buckets (like Meteora).
The core idea is the same: dividing the price curve into segments so liquidity can be placed precisely where it’s needed.
What are liquidity shapes?
Liquidity shapes describe how a liquidity provider distributes their capital across multiple price ranges.
Instead of choosing a single band, LPs can spread liquidity in different patterns depending on their strategy. Some common liquidity shapes include:
Narrow range: Liquidity is stored tightly around the current price, offering the highest capital efficiency and highest reward fee potential, but it's also the highest risk of going out of range.
Wide range: Liquidity covers a large price band. Fee efficiency is lower, but there's less maintenance required, and it's less likely to go out of range.
Multi-range strategies: Liquidity is split across several ranges to create more complex shapes. For example, a bell curve around the current price, or a ladder of liquidity above and below the market.
Professional LPs often design custom liquidity shapes to balance risk, volatility, and expected trading activity. These strategies can significantly impact returns.
Non-concentrated liquidity vs concentrated liquidity
Traditional AMMs such as early versions of Uniswap, SushiSwap, or PancakeSwap use what’s often called full-range liquidity.
In those systems, liquidity is distributed evenly across all possible prices, and LPs don't control where their capital is used. As such, a large portion of liquidity sits unused because most trading happens near the current market price.
For example, if ETH is trading at $2,000, liquidity placed at $10 or $100,000 is essentially irrelevant. This creates major inefficiencies and concentrated liquidity changes this model.
CLMMs can instead define a custom range, such as:
$1,800 – $2,200 for ETH/USDC
$0.95 – $1.05 for a stablecoin pair
Because the liquidity is tightly packed around the current price, the pool becomes far deeper where trading actually happens, resulting in capital efficiency. A smaller amount of liquidity can generate the same trading depth that previously required much larger pools.
| Feature | Traditional AMMs | CLMMs |
|---|---|---|
| Liquidity distribution | Spread across entire price curve | Placed within specific price ranges |
| Capital efficiency | Lower | Higher |
| LP strategy | Mostly passive | Actively managed |
| Fee generation | Consistent but lower | Higher when price stays in range |
Another structural difference is how liquidity positions are represented. In traditional AMMs like Uniswap v2, liquidity providers receive fungible LP tokens that represent their share of the pool.
With concentrated liquidity, each position has unique parameters such as its price range and fee tier. Because no two positions are necessarily identical, protocols like Uniswap v3 represent LP positions as NFTs. These NFTs store the details of the liquidity position and allow it to be transferred, traded, or integrated into other DeFi applications.
Why use concentrated liquidity?
The main advantage of concentrated liquidity is capital efficiency. In older AMM designs, a huge portion of liquidity sits unused because it’s spread across unrealistic price levels. Concentrated liquidity solves this by placing funds exactly where trading happens, and this creates several benefits:
More efficient capital: Liquidity providers can earn the same fees using far less capital because their liquidity is active near the current market price.
Better pricing for traders: More liquidity around the active price means lower slippage for traders, which makes the exchange more competitive.
Higher fee potential: Since liquidity is concentrated in smaller ranges, LPs can capture a larger share of trading fees when their range is active.
Flexible strategies: LPs can actively manage their positions, adjust ranges as markets move, and deploy different liquidity shapes depending on volatility.
This flexibility allows sophisticated strategies that weren’t possible with earlier AMMs, changing liquidity providers from passive participants into active market makers.
Challenges & risks of concentrated liquidity
While concentrated liquidity offers higher efficiency, it also introduces additional risks and complexity. Liquidity providers need to actively manage their positions to avoid common pitfalls.
Impermanent loss
Impermanent loss still exists in concentrated liquidity pools and can sometimes be more pronounced. If the asset price moves significantly in one direction, LPs may end up holding mostly one asset instead of the balanced pair they originally deposited.
Example:
If ETH rises sharply in an ETH/USDC pool, the LP may end up holding mostly USDC.
This happens because traders buy the cheaper asset from the pool as the price moves.
Out-of-range liquidity
A unique risk of concentrated liquidity is that positions can go out of range. If the market price moves outside the chosen band, the liquidity stops facilitating trades, and fees stop being generated.
To continue earning fees, LPs must reposition their liquidity, either manually or with a pre-existing automated strategy.
Gas fees and repositioning costs
On chains with higher transaction costs, frequently adjusting liquidity ranges can become expensive. If an LP needs to reposition often, gas fees may eat into profits. This has historically been a challenge on Ethereum during periods of high network activity.
Strategy complexity
Concentrated liquidity requires more decision-making than traditional AMMs. LPs need to consider volatility, market trends, optimal range width, and rebalancing frequency.
For casual users, this can be daunting. But many protocols now offer automated vaults or strategy managers that handle this.
Concentrated liquidity protocols on Ethereum
Ethereum is where concentrated liquidity first became widely adopted. The most influential protocol is Uniswap v3, which introduced the model in 2021.
Uniswap v3 uses a tick-based system where liquidity providers choose upper and lower price boundaries. Liquidity is active only within that range, and each position is represented as an NFT.
Key features include:
Custom price ranges
Multiple fee tiers
Tick-based liquidity placement
Uniswap v3 set the standard for concentrated liquidity AMMs. Other Ethereum protocols have built on this concept or introduced variations, including Curve Finance and Balancer.
Concentrated liquidity protocols on Solana
Solana has several major protocols that use concentrated liquidity, often optimized for the network’s high throughput and low transaction costs.
Raydium
Raydium introduced concentrated liquidity pools similar to Uniswap v3. Users can define price ranges for their liquidity and earn trading fees when trades occur within those ranges.
Orca
Orca offers a user-friendly version of concentrated liquidity called Whirlpools. Whirlpools simplify liquidity placement and include:
Tick-based liquidity ranges
Visual liquidity management tools
Low fees
Orca focuses heavily on usability, making concentrated liquidity more accessible to everyday users.
Meteora
Meteora introduces a more advanced approach with dynamic liquidity management and automated strategies. Its pools can adjust liquidity distribution based on market conditions, which helps reduce the manual management burden for LPs.
Concentrated liquidity protocols on Osmosis
Osmosis, a major decentralized exchange in the Cosmos ecosystem, implements concentrated liquidity under the name supercharged liquidity. The concept is similar to Uniswap v3 but adapted for the Cosmos environment.
Liquidity providers can define price ranges for their positions, allowing capital to be deployed more efficiently compared to Osmosis’s earlier pool designs. Because Osmosis operates within an interconnected network of blockchains, supercharged liquidity can support trading across many different Cosmos assets.
How is concentrated liquidity provision taxed?
Most tax offices haven’t caught up with non-concentrated liquidity provision, let alone CLMMs, but that doesn’t mean your rewards won’t be taxable. It’ll all come down to the specific transaction and the existing guidance around similar transactions.
For CLMMs, this means the point you open a position is likely a taxable event (as you’re trading crypto for an NFT). Similarly, the point at which you exit a position is likely a taxable event as a trade.
Your rewards may be taxed as income or capital gains, depending on how and when you realise them in your chosen protocol.
If you don’t realise your profit until the point you exit your position, this is more likely to be treated as a capital gain. But if you regularly receive rewards in relation to your position, this is more likely to be treated as ordinary income.
As ever, in the absence of existing guidance, you should speak to an experienced crypto accountant for advice.
How to calculate CLMM taxes
Liquidity provision is taxable, and concentrated liquidity provision creates additional complications when it comes to calculating your taxes, because the majority of crypto tax software can’t handle these positions.
This is because positions are typically represented by NFTs, unlike in a traditional LP, where you’d have LP tokens representing your stake. So when you open your position, you receive an NFT, and you generally return that NFT at the point you close your position. As well as this, when you’re adding or reducing a position, you may send or receive tokens without receiving anything in return. It's this limited transaction data that makes accurately tracking the cost basis of a position difficult for many software providers.
Fortunately, Koinly supports major concentrated liquidity protocols across Solana and Ethereum, with unique transaction handling for accurate calculations.
