Concentrated Liquidity

Swapmode introduces an advanced feature for liquidity providers: the ability to use "concentrated" capital within specific price ranges. Providers can choose a precise price interval to supply liquidity, focusing their capital where trading is most frequent. This approach boosts the efficiency of investments, particularly in stablecoin pools where asset prices are relatively stable. In such pools, the capital efficiency can increase dramatically, up to 4000x.

Swapmode's Concentrated Liquidity (CL) feature, inspired by and improving upon Uniswap V3's model, is also compatible with Uniswap V3 tools. This innovation enhances the Swap, Liquidity, and Farm functionalities, offering users a sophisticated system to maximize their returns. For a detailed understanding of these benefits and how they reshape trading dynamics, refer to our comprehensive documentation.

Swapmode redefines liquidity provision by offering LPs precise control over their capital's price range allocation. This system aggregates individual positions into a single pool, forming a unified curve for trading. By concentrating capital in the most traded price ranges, Swapmode ensures capital-efficient trading, enhances liquidity, reduces slippage, and preserves capital across various fee tiers.

In traditional systems, liquidity is spread across an extensive price curve (x*y=k), often leading to underutilized capital. For example, in a typical USDT/USDC pair, only around 0.50% of capital might be actively traded between $0.99 and $1.01, despite this being the expected high-volume trading range. Classic LPs face the issue of earning fees on a minimal portion of their capital, potentially not compensating for the price risk or "impermanent loss." Additionally, this broad distribution of liquidity can result in high slippage for traders.

Swapmode addresses these inefficiencies by allowing LPs to concentrate their capital within tailored price ranges. This not only increases liquidity where it's most needed but also allows LPs to customize their investment strategies and risk profiles. For example, an LP in the ETH/USDC pool could allocate capital to specific ranges like $2,000-$3,000 and $2,250-$2,500, effectively creating a tailored liquidity profile.

This model permits the combination of multiple concentrated positions within a single pool, enabling LPs to mimic any automated market maker or active order book. It ensures that users trade against a pool's collective liquidity without incurring additional gas costs per LP. Moreover, trading fees generated within a particular price range are proportionally distributed among LPs who contributed to that range, aligning rewards with provided liquidity.

Concentrated Liquidity, inspired by the v3 model, refines the distribution of liquidity in a pool by allowing it to be confined within specific price ranges. Traditionally, in the x * y = k model, liquidity was evenly distributed across all prices, from zero to infinity, leading to underutilization of assets.

Concentrated Liquidity introduces the concept of a "position," where LPs can focus their liquidity within a finite, more specific price range rather than the expansive (0, ∞) range. Each position behaves like a mini constant product pool with augmented virtual reserves tailored for its specific range. A position must hold enough of asset X and asset Y to handle price movements to its upper and lower limits, respectively. This setup is depicted in Fig. 2, where a position within a range [𝑝𝑎, 𝑝𝑏] is shown, with the current price 𝑝𝑐 falling within this range. The actual reserves of the position are denoted by 𝑥_real and 𝑦_real.

If the price exits a position's range, that position's liquidity becomes inactive, stopping fee accrual. In this inactive state, the position is entirely composed of one asset, as the other asset's reserve is entirely used up. However, if the price moves back into the position's range, the liquidity becomes active again.

LPs can establish multiple positions, each with its own distinct price range. This flexibility allows them to tailor their liquidity distribution across the price spectrum, enabling the market to organically determine liquidity distribution. Rational LPs can optimize their capital by concentrating liquidity around the current price and dynamically adjusting their positions—adding or removing tokens—as prices fluctuate to maintain active liquidity within their chosen ranges.