Concentrated Liquidity versus Constant Product (CLMM versus CPMM)

Concentrated Liquidity Market Making

  • You must provide a range of prices you want to provide liquidity for. The tighter the range, the more risk you are taking. The wider the range, the less risk (but still more than CPMM!). If you set the range from 0 to infinity, the CLMM converges to CPMM.
  • If the price of the pair of assets falls outside of your range, you LP position is essentially inactive. You are not earning any fees.
  • In addition, if the price of the pair of assets falls outside of your range, you are left with only 1 of the 2 assets you may have initially supplied. So if the price of ETH/USDC falls below your range, you are left with only ETH. If the price of ETH/USDC increases above your range, you are left with only USDC.
  • You rarely supply the assets in the traditional 50/50 value you are used to. There is only 1 price near the middle of your range (near not exactly the middle) where your value of the two tokens is 50/50 (that price is sqrt(lower bound * upper bound)). This is very different than the CPMM where the value is always 50/50 for a 50/50 CPMM pool.
  • You have the potential to earn more fees per dollar invested versus a CPMM, but only if the price of the assets is inside of your range.
  • You have the potential for more IL as well. IL is exacerbated (levered, multiplied) relative to a CPMM LP.
  • Unless you are providing Concentrated Liquidity to highly correlated (very similar assets), you will want to actively manage your LP position. CLMM is not for the faint of heart!

Stylized Example of CPMM, CLMM and Holding

  1. Hold your tokens exactly how you have them, x=5 and y=500 (blue line).
  2. Supply liquidity to a CPMM, initially supply x=5 and y=500. This ratio will change as the price changes (orange line).
  3. Supply liquidity to a CLMM, initially supply x=5 and y=500. Set your lower and upper bounds of your price range is 66.67 and 150. You no longer receive any fee yield if the price of X / price of Y (or supply y / supply x) is outside of 66.67–150 (grey line).
  4. Supply liquidity to a CLMM, initially supply x=5 and y=500. Set your lower and upper bounds of your price range is 83.33 and 120. So you no longer receive any fee yield if the price of X / price of Y (or supply y / supply x) is outside of 83.33–120 (yellow line). This is the most concentrated and most risky position.
This shows you the total Profit/Loss from each trade as the price of X increases or decreases. Holding is a straight line (delta 1). CLMM is 100% token X (risky token) when the price of X is below the lower bound (so a straight line/delta 1). CLMM is a 100% token Y (stablecoin) when the price of X is above the upper bound (flat horizontal line/delta 0).
This shows you the IL (trade profit/loss minus holding profit/loss) from each trade as the price of X increases or decreases.
This shows you the total Profit/Loss from each trade as the price of X increases or decreases. Holding is a straight line (delta 1). CLMM is 100% token X (risky token) when the price of X is below the lower bound (so a straight line/delta 1). CLMM is a 100% token Y (stablecoin) when the price of X is above the upper bound (flat horizontal line/delta 0).
This shows you the IL (trade profit/loss minus holding profit/loss including fees) from each trade as the price of X increases or decreases.

Conclusion

About the Author

--

--

--

TradFi background, DeFi Degen. Love SOL, ADA, ETH, DOT, NEAR, Aurora, ALGO, MIOTA plus NFTs

Love podcasts or audiobooks? Learn on the go with our new app.

Recommended from Medium

STRT BUTTON X CREO ENGINE

ETHLisbon, an Ephemeral Centro

Monumental and imposing gate to the city at the waterfront

Cryptocurrency Price and Increasing Crypto Utility by Driving Crypto Adoption

What’s Your Financial Plan for The Metaverse?

Bitclout NFT sales help support earthquake victims in Haiti

2ChoicesDAO product update

#TradeBytes 1.2 Edition — A Trader Education Series by #CryptoMan

Bitget Newly Listed Coin: ENJ

Get the Medium app

A button that says 'Download on the App Store', and if clicked it will lead you to the iOS App store
A button that says 'Get it on, Google Play', and if clicked it will lead you to the Google Play store
Marco_112358

Marco_112358

TradFi background, DeFi Degen. Love SOL, ADA, ETH, DOT, NEAR, Aurora, ALGO, MIOTA plus NFTs

More from Medium

Wormhole Protocol vs. Portal Bridge: What’s the difference?

Presenting the Initiator

An Avalanche of DeFi, Part II

Frax Finance Using Chainlink to Bring U.S. CPI Data On-Chain in Support of the Frax Price Index.