πConcentrated Liquidity
Last updated
Last updated
With the introduction of Quantum, liquidity providers can now take advantage of "concentrated" capital within smaller price intervals. This means they can choose a custom price range when providing liquidity, allowing their capital to be focused in areas where the majority of trading takes place. This approach makes their investments work harder for them, particularly in stablecoin pools, where assets maintain a relatively stable price in relation to one another, and the capital multiplier can reach up to 4000x. Arbidex's Quantum, built upon Uniswap V3 with added enhancements, offers compatibility with tools designed for Uniswap V3. Explore the benefits of this cutting-edge system and how it impacts Swap, Liquidity, and Farm features in our medium article.
Giving individual LPs granular control over what price ranges their capital is allocated to. Individual positions are aggregated together into a single pool, forming one combined curve for users to trade against. Quantum offers capital-efficient trading and lower trading slippage by βconcentratingβ the capital on the most actively traded price range. This ensures more liquidity, less slippage, and greater capital preservation for traders, regardless of the fee tier.
In Arbidex Classic, liquidity is distributed uniformly along an x*y=k price curve, with assets reserved for all prices between 0 and infinity. However, the majority of this liquidity remains unused for most pools. For example, in the Classic USDT/USDC pair, only about 0.50% of capital is reserved for trading between $0.99 and $1.01, which is the price range where LPs would expect to see the highest volume and consequently earn the most fees.
As Classic LPs only earn fees on a small fraction of their capital, they may not be adequately compensated for the price risk ("impermanent loss") they assume by holding large inventories in both tokens. Additionally, traders often face high levels of slippage since liquidity is thinly dispersed across all price ranges.
Arbidex's Quantum allows LPs to concentrate their capital within custom price ranges, offering more liquidity at preferred prices. This enables LPs to create individualized price curves that reflect their personal preferences.
LPs have the flexibility to combine multiple concentrated positions within a single pool. For example, an LP in the ETH/USDC pool might allocate $100 to the price ranges of $1,000-$2,000 and an additional $50 to the ranges of $1,500-$1,750.
By doing this, an LP can mimic the shape of any automated market maker or active order book.
Users trade against the combined liquidity of all individual curves without incurring any increase in gas costs per liquidity provider. The trading fees collected at a specific price range are divided pro-rata among LPs based on the amount of liquidity they contributed to that particular range.
The central concept of Concentrated Liquidity revolves around the Uniswap v3 model, which confines liquidity within a specific price range. In earlier versions, liquidity was uniformly distributed along the π₯ Β· π¦ = π reserves curve, with π₯ and π¦ representing the reserves of two assets X and Y, and π as a constant. This meant that liquidity was available across the entire price range (0, β). While easy to implement and efficient in aggregating liquidity, this approach left many assets in a pool unused.
Given this observation, it seems logical to allow LPs to concentrate their liquidity within smaller price ranges than (0, β). We refer to liquidity focused within a finite range as a position. A position only needs to maintain enough reserves to support trading within its range, effectively acting as a constant product pool with larger virtual reserves in that range. Specifically, a position needs to hold sufficient asset X to cover price movement to its upper bound and enough asset Y to cover price movement to its lower bound. Fig. 2 illustrates this relationship for a position on a range [ππ, ππ] and a current price ππ β [ππ, ππ], with π₯real and π¦real representing the position's real reserves.
When the price moves outside a position's range, the position's liquidity becomes inactive and no longer earns fees. At this point, the liquidity consists entirely of a single asset, as the reserves of the other asset must have been entirely depleted. If the price reenters the range, the liquidity becomes active again.
The provided liquidity can be measured by the value πΏ, which equals βπ. The real reserves of a position are defined by the curve:
Liquidity providers can create as many positions as desired, each within its own price range. This allows LPs to approximate any chosen liquidity distribution across the price space, (see Fig. 3 for examples) and serves as a mechanism for the market to determine the allocation of liquidity. Rational LPs can minimize their capital costs by concentrating liquidity within a narrow band around the current price and adding or removing tokens as the price moves to maintain active liquidity.
