How Concentrated Liquidity Market Makers Increase Capital Efficiency
When LPs contribute liquidity to a CLMM, they can choose the price range in which they want their tokens to be distributed, for instance, from $20 to $30. Each "tick," or division of the range, distributes liquidity evenly.
For instance, a tick for $21 tokens, $22 tokens, and so on might be present in the $20–$30 price range. An LP cannot get fees if the market value of the tokens they have supplied moves outside of the predetermined range. The tokens stay supplied in these ticks until they are withdrawn.
In contrast to first-generation AMMs, capital efficiency on a CLMM is exponentially higher since tokens are distributed at or close to the current market value rather than throughout a wide price range. With a CLMM, it is no longer necessary to supply 10 tokens at the current token price with 1,000 tokens. For LPs, ten tokens invested in a CLMM can provide the same yield as one thousand tokens distributed inefficiently from zero to infinity.
Better liquidity management benefits LPs, traders, and projects. With fewer tokens deposited, LPs can make more fees while spending less money that could be utilised for growth elsewhere in DeFi. Traders will also experience less slippage, and projects will be better able to realise deep liquidity for their tokens.