Concentrated liquidity allows liquidity providers to specify price ranges for their capital rather than spreading it across all possible prices, greatly improving capital efficiency but increasing complexity and risk. Traditional AMMs like Uniswap v2 distribute liquidity uniformly from zero to infinity, most of which sits unused since prices rarely move to extreme values. Concentrated liquidity, pioneered by Uniswap v3, lets LPs choose: 'I want to provide liquidity for ETH/USDC only between $1,800 and $2,200.' Within that range, the LP's capital works much harder, earning more fees per dollar deployed. The capital efficiency gains are dramatic: a concentrated position can be 100x more capital-efficient than a full-range position. The trade-offs are significant. If price moves outside your range, your liquidity becomes inactive, earning nothing while still exposed to impermanent loss. Active management is required: LPs must monitor positions and adjust ranges as prices move. This has spawned an ecosystem of automated concentrated liquidity managers (Arrakis, Gamma) that handle position management for fees. Impermanent loss is amplified in concentrated positions because the rebalancing effect operates over a narrower range. Professional LPs treat concentrated liquidity as active trading rather than passive income.
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