Concentrated Liquidity

With the introduction of BaseX, liquidity providers can now capitalize on "concentrated" capital within narrower price intervals. This enables them to select a custom price range when providing liquidity, concentrating their capital where most trading occurs. This method allows their investments to work more efficiently, especially in stablecoin pools where assets maintain a relatively consistent price in relation to each other. In these pools, the capital multiplier can soar up to 4000x. BaseX's CL, developed based on Uniswap V3 but with added enhancements, is compatible with tools designed for Uniswap V3. Dive into the advantages of this state-of-the-art system and its implications on Swap, Liquidity, and Farm features in our documentation.

By granting individual LPs granular control over the price ranges to which their capital is allocated, individual positions are aggregated into a single pool, creating one unified curve for users to trade against. BaseX ensures capital-efficient trading and reduced trading slippage by "concentrating" capital on the most actively traded price range. This approach guarantees enhanced liquidity, diminished slippage, and superior capital preservation for traders across all fee tiers.

In BaseSwap, liquidity is evenly distributed along an x*y=k price curve, with assets allocated for all prices between 0 and infinity. However, for most pools, a significant portion of this liquidity remains untouched. For instance, in the Classic USDT/USDC pair, only approximately 0.50% of capital is designated for trading between $0.99 and $1.01. This is the price range where LPs would anticipate the highest trading volume and, as a result, accrue the most fees.

As Classic LPs earn fees on only a small fraction of their capital, they might not receive suitable compensation for the price risk (known as "impermanent loss") they take on by maintaining substantial inventories of both tokens. Furthermore, traders frequently encounter high slippage levels since liquidity is thinly spread across all price ranges.

BaseX permits LPs to concentrate their capital within custom price ranges, providing greater liquidity at favored prices. This empowers LPs to establish individualized price curves that mirror their personal preferences.

LPs are given the flexibility to combine multiple concentrated positions within one pool. For instance, an LP in the ETH/USDC pool might allocate $100 to the price range of $1,000-$2,000 and an additional $50 to the range of $1,500-$1,750.

By adopting this approach, an LP can emulate the shape of any automated market maker or active order book.

Users trade against the collective liquidity of all individual curves without experiencing any increase in gas costs per liquidity provider. Trading fees accumulated within a specific price range are distributed pro-rata among LPs based on the liquidity they contributed to that specific range.

The core concept of Concentrated Liquidity is based on the v3 model, which confines liquidity to a specific price range. In earlier versions, liquidity was evenly distributed along the $𝑥×𝑦=𝑘x×y=k$ reserve curve, where $𝑥x$ and $𝑦y$ represent the reserves of two assets X and Y, and $𝑘k$ is a constant. This implied that liquidity was available across the entire price range (0, ∞). While this was straightforward to implement and efficient in pooling liquidity, it meant that many assets in a pool remained unused.

Given this observation, it's logical to allow LPs to concentrate their liquidity within more specific price ranges than the broad (0, ∞). We term liquidity that's focused within a finite range as a "position." Such a position only has to maintain reserves adequate for trading within its designated range. It effectively acts like a constant product pool but with augmented virtual reserves for that range. To elaborate, a position must hold a sufficient quantity of asset X to accommodate price movements to its upper limit, and an ample amount of asset Y to account for shifts to its lower limit. Fig. 2 demonstrates this relationship for a position with a range [𝑝𝑎, 𝑝𝑏] and a prevailing price 𝑝𝑐 within [𝑝𝑎, 𝑝𝑏], where 𝑥real and 𝑦real denote the position's actual reserves.

When the price shifts outside a position's range, the liquidity of that position becomes inactive and ceases to earn fees. In this state, the liquidity is composed solely of one asset, given that the reserves for the other asset must have been fully exhausted. Should the price re-enter the range, the liquidity is reactivated.

Liquidity providers have the flexibility to create as many positions as they wish, each within its distinct price range. This enables LPs to approximate any preferred liquidity distribution across the price spectrum, acting as a mechanism for the market to dictate the distribution of liquidity. Rational LPs can reduce their capital costs by concentrating liquidity within a tight band around the current price, adjusting by adding or removing tokens as the price fluctuates to sustain active liquidity.