CONCENTRATED LIQUIDITY
Concentrated liquidity was first introduced in Uniswap v3 and continues to work the same way in v4, giving liquidity providers consistent control over where their capital is deployed.
Introduction
Concentrated liquidity allows liquidity providers to allocate their capital within specific price ranges rather than spreading it across all possible prices. This represents a fundamental shift from earlier AMM designs where liquidity was evenly distributed along the entire price curve from zero to infinity**.
While the old approach ensured liquidity was always available at any price, it came with a significant drawback: most of the capital sat unused. In practice, trading activity tends to cluster around certain price levels, leaving vast amounts of liquidity idle.
Stablecoin pairs illustrate this perfectly. Since stablecoins maintain relatively fixed exchange rates, nearly all trading happens within a narrow band around parity. Historical data shows that in traditional pools like DAI/USDC, less than 1% of total capital was actually used for trades between $0.99 and $1.01—the range where most volume occurs and where fees are earned.
Concentrated liquidity solves this inefficiency by letting providers focus their capital exactly where it's needed. A liquidity provider can choose to deploy funds only within the $0.99 to $1.01 range for a stablecoin pair, for example. This creates deeper liquidity around current prices, improving execution for traders while allowing providers to earn more fees per dollar of capital. Each focused allocation is called a position, and providers can create multiple positions per pool, each with different price ranges, building customized liquidity distributions that match their strategies.
Active Liquidity
Liquidity positions have defined price boundaries. When the market price moves outside these boundaries, the position becomes inactive and stops earning trading fees.
As price moves through a position's range, the composition of assets shifts. Swaps gradually convert one asset into the other until the position holds only a single asset when price reaches the boundary. This behavior differs from earlier AMM versions where prices rarely approached the theoretical limits of zero or infinity, so positions rarely became fully one-sided.
If price later moves back into a position's range, the liquidity reactivates and fee earning resumes. This dynamic creates an incentive for providers to position their liquidity where they expect price to remain, balancing the desire for higher fee concentration against the risk of becoming inactive.
Providers can create unlimited positions with different price ranges, allowing the market to organically determine optimal liquidity distribution. Rational providers naturally concentrate their capital where trading is most active, creating efficient price discovery while maintaining flexibility.
Ticks
Concentrated liquidity relies on ticks: discrete price boundaries that divide the continuous price spectrum into manageable segments.
Each tick represents a 0.01% price movement. When creating a position, providers select a lower tick and an upper tick that define their position's boundaries.
During swaps, the protocol uses all available liquidity within the current tick interval. When price crosses into a new tick, the contract activates any positions that have boundaries at that tick, seamlessly incorporating new liquidity into the active trading range.
Not all ticks can be active simultaneously. The spacing between potentially active ticks depends on the pool's fee tier. Lower fee pools allow tighter tick spacing, enabling more granular liquidity placement. Higher fee pools use wider spacing, reducing computational complexity.
Crossing an active tick during a swap incurs additional gas costs because the contract must process the activation of new positions. However, inactive ticks have no impact on swap costs.
For stablecoin pairs where precision matters most, tighter tick spacing enables providers to place liquidity with greater granularity. This results in better prices for traders and more efficient capital utilization, making concentrated liquidity particularly valuable for stablecoin trading.