How Does a Concentrated Liquidity Pool Modify the Constant Product Formula’s Impact?
Concentrated liquidity pools (CLPs) allow LPs to allocate their capital within a specific price range, rather than across the entire (0, infty) range. This means the x y = k formula is only active within the chosen range.
This greatly increases capital efficiency, as the liquidity is concentrated where most trading occurs. However, it also increases the LP's exposure to impermanent loss outside their range.
Glossar
Concentrated Liquidity Pool
Protocol ⎊ A concentrated liquidity pool, within the context of cryptocurrency derivatives and options trading, represents a structural evolution from traditional Automated Market Makers (AMMs).
Capital Efficiency
Leverage ⎊ Capital efficiency, within cryptocurrency and derivatives, fundamentally represents the maximization of risk-adjusted returns relative to capital at risk, a metric increasingly vital given regulatory constraints and market volatility.
Concentrated Liquidity
Allocation ⎊ ⎊ Concentrated liquidity represents a departure from traditional automated market maker models by enabling liquidity providers to specify precise price ranges where their capital will be deployed, fundamentally altering capital efficiency.