Decentralized Exchange (DEX) protocols have become a key part of the decentralized finance (DeFi) ecosystem where liquidity and liquidity providers play a critical role in keeping the rapidly growing space moving.
While DEX protocols have seen billions in daily transaction volume, the liquidity market is gradually shifting away from traditional liquidity methods towards concentrated liquidity. Previous liquidity was evenly distributed along the price curve between zero and infinity, while in the new system liquidity is allocated within a custom price range.
For example, in the case of a stablecoin/stablecoin pair, a liquidity provider (LP) may decide to allocate capital entirely in the range of $0.99 – $1.01. As a result, traders will have more liquidity around the mid-price and LPs will earn more trading fees on their cash.
The concentrated liquidity formula aims to improve capital efficiency by compensating for the shortcomings of the original formula. Liquidity can now be allocated to a price range in the new model, resulting in a concentrated liquidity position. LPs can open as many positions in the pool as they wish, allowing them to create their own price curves based on their specific needs and preferences.
Uniswap switched to concentrated liquidity with its move to V3 in May of last year and has already been reaping the benefits, with a 500% increase in daily volume after the switch. Similarly, another DEX called Algebra has been put forward to make its case for the DEX race with concentrated liquidity integration.
For one thing, Uniswap runs on top of Ethereum, while Algebra chose Polygon as its base layer. The new DEX claims to be more efficient with its dynamic pricing, integrated farming, and cross-chain integration support.
Speaking about the main advantages of Algebra over Uniswap, DEX co-founder Alexandra Korneva told Cointelegraph:
“Uniswap does not have farming on the platform, so users need to request external smart contracts to farm tokens. To improve this situation, Algebra has introduced integrated farming; allowing users to push their extra tokens into pools and earn rewards. You do not need to access external platforms to farm and make a profit.”
Related: Uniswap launches venture capital wing for Web3 investments
Pools of concentrated liquidity seem to be the latest trend among DEX players, as not only on Ethereum, there have also been several projects of concentrated liquidity on Solana and Binance Smart Chain.