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Concentrated Liquidity Market Makers
In classic Automated Market Maker (AMM) like Uniswap v2 and Pancakeswap v2, liquidity is distributed evenly along an x*y=k price curve, with assets reserved for all prices between 0 and infinity.
However, in many cases, most trading occurs within a narrow price range, leaving a large portion of the liquidity unused. This means LPs only earn fees on a small portion of their capital, which may not compensate for the risk they take by holding both tokens. Additionally, traders may experience high slippage due to thin liquidity across all price ranges.
With UpDex, LP's can provide liquidity within a specified price range of their choice - this is called concentrated liquidity. For example, an LP can choose to provide liquidity between $0.99 and $1.01 for the USDC/USDT pair and earn trading fees as long as the price remains within that range. This can potentially increase LP earnings and reduce slippage for traders.
By concentrating their liquidity, LPs can provide the same liquidity depth as classic AMM (Univ2, Pancakev2) within specified price ranges while putting far less capital at risk. The capital saved can be held externally, invested in different assets, deposited elsewhere in DeFi, or used to increase exposure within the specified price range to earn more trading fees.
Let's illustrate with an example:
Michael and Bryan both provided liquidity in UP/USDT pool with $1,000 USD worth of token assets. The current price of$UPis 5 USDT.Similar to Uniswap v2, Michael provided his liquidity across the entire price range. Therefore he deposited all of his capital, 500 USDT and 100$UP.Bryan utilize the new concentrated liquidity feature in UpDEX and created a position with a price range of 2 to 12.5 USDT per$UP. He deposited 185 USDT and 37$UP, worth a total of $370. He is now able to spend the remaining $630 elsewhere, like buying & locking$UPtoveUPto utilize the ve(3,3) mechanism yield or Upfront Stake to receive more yield reward while receiving a series of Upfront ecosystem benefits.As long as$UPstays within the price range of 2 to 12.5, both Michael and Bryan will receive the same amount of trading fee rewards while Bryan deposited way less capital to the liquidity pool.
If the market price of an asset moves beyond the price range specified by an LP in the UpDEX, their liquidity is effectively removed from the pool and they stop earning fees. During this time, their liquidity is only composed of the less valuable of the two assets until the market price returns within their specified range or they update their range to match current prices.
In UpDEX, it is possible that no liquidity may exist in a particular price range, but it's expected that LPs will keep updating their ranges to ensure coverage of the current market price.
The UpDEX LP customizability introduces a new order feature called "range orders" that complements market orders.
LPs can deposit a single token within a custom price range, and if the market price enters that range, they can sell one asset for another and earn swap fees. Depositing to a narrow range is similar to a traditional limit order. When the market price moves out of the range, the LP's liquidity fully converts to the other asset, and they must withdraw their liquidity to avoid automatically converting back.
For example, if the current price of$UPis below 1.001 USDT, Daniel could add $1000 worth of$UPto the range of 1.001 — 1.002 UP/USDT.Once$UPtrades above 1.002 UP/USDT, Daniel's liquidity will have fully converted into USDT. Daniel must withdraw his liquidity (or use a third-party service to withdraw on his behalf) to avoid automatically converting back into$UPif UP/USDT starts trading below 1.002.
The average execution price of a fully executed range order is the geometric average of the minimum and maximum price. Range orders within wider ranges can be used for profit-taking, buying the dip, and primary issuance events, where issuers can deposit liquidity in a single asset and specify the range of prices across which they want to sell their tokens.
In the v3 protocol, liquidity positions are no longer interchangeable, and each LP's position is represented as a non-fungible token (NFT) due to custom price curves.
However, shared positions can be made interchangeable through peripheral contracts or partner protocols. Moreover, trading fees are not automatically reinvested back into the pool for LPs.
As time progresses, it is expected that more complex strategies will be tokenized, allowing LPs to participate passively. This could include various strategies like multiple positions, automatic rebalancing, fee reinvestment, and lending.
Last modified 6mo ago