Key Takeaways
CLMMs allow liquidity providers to allocate capital within a custom price range on a decentralized finance (DeFi) protocol, rather than spreading funds across all possible prices.
By concentrating funds near the current market price, providers may earn more trading fees with the same amount of capital compared to traditional AMM models.
CLMMs require active management. If the market price moves outside a provider's chosen range, the position stops earning fees until the price returns or the range is adjusted.
The risk of impermanent loss can be amplified in CLMMs because capital is more exposed to price movements within a narrow range.
Introduction
In the early days of decentralized finance (DeFi), providing liquidity was mostly a passive activity. You deposited two tokens into a liquidity pool, and the underlying smart contract spread your funds across every possible price. This model, known as the standard Automated Market Maker (AMM), was simple to use but not particularly efficient.
Concentrated Liquidity Market Makers (CLMMs) changed this. Instead of spreading your capital across all prices, CLMMs let you focus it where trading actually happens. This makes your funds more useful, which can mean higher fee earnings on less capital.
You can think of it like this: in a standard AMM, you're setting up a shop on every mile of a highway crossing the entire country, including deserted stretches. CLMMs let you open your shop only on the busy sections. Your investment goes further because it's positioned where demand exists.
What Is Concentrated Liquidity?
Concentrated liquidity means capital that is allocated within a specific price range you choose. In earlier AMM versions, liquidity was distributed uniformly across all prices. A large portion of the assets in a pool was often never used for trading, especially for stablecoin pairs where prices rarely deviate far from $1.00.
With CLMMs, you can choose to provide liquidity only between, say, $0.99 and $1.01 for a stablecoin pair. This concentrates your capital right where trades are most likely to occur, making it far more efficient than spreading it thinly across distant price levels.
How Do CLMMs Work?
Ticks
To make custom price ranges possible, CLMMs divide the price spectrum into small, discrete steps called ticks. Ticks act as the boundaries between price areas. When you create a position, you choose a lower tick and an upper tick to define the edges of your LP tokens range. Your capital sits between these two boundaries and earns fees from all trades that pass through your range.
Active liquidity
Your position is only "active" when the current market price is within the range you selected. While the price stays inside your range, you earn a share of trading fees from the pool. If the price moves up or down and crosses your chosen tick boundaries, your position becomes inactive. You stop earning fees until the price returns, or until you manually adjust your range.
Capital efficiency
The central benefit of CLMMs is capital efficiency. Because you aren't spreading capital across distant price levels, you can earn a similar amount of fees with less total capital compared to a standard AMM. A provider in a tightly concentrated range may earn the same daily fees with $1,000 as a provider in a standard pool earns with $5,000, simply because the concentrated capital is being used by more trades.
The Risks of CLMMs
CLMMs can offer better fee income than standard AMMs, but they require more active involvement and carry specific risks.
Going out of range
If the price exits your chosen interval, your position effectively converts fully into one of the two assets in the pair. At this point, you hold only one token and earn no fees. You need to either wait for the price to return or close and reopen your position with a new range.
Amplified impermanent loss
Because your liquidity is concentrated, impermanent loss can be amplified compared to standard AMMs. If the market moves sharply against your position, the value of your holdings may decline faster than in a traditional pool. This is especially relevant during volatile market conditions.
Active management required
Standard AMM pools are relatively hands-off. CLMMs are not. You need to select a price range, monitor market movements, and rebalance your position when necessary. Some users employ active management strategies, adjusting ranges frequently based on price action. Others use automated CLMM management tools that rebalance positions on their behalf.
Uniswap V4 and the Next Generation of CLMMs
Uniswap V4, which launched in early 2025, pushed the CLMM model further. V4 introduced "hooks," which are pieces of custom code that developers can attach to a pool to modify its behavior. Hooks can enable features like dynamic fee adjustment, on-chain limit orders, or custom oracles built directly into the pool logic.
This development has expanded what is possible with concentrated liquidity. Pools are no longer fixed in their mechanics. Developers can build highly specialized market structures on top of the same core CLMM framework. This has contributed to continued growth in DeFi liquidity depth and the range of trading tools available to users.
FAQ
What is the difference between a CLMM and a standard AMM?
A standard AMM spreads a provider's capital across all price levels from zero to infinity, making most of it inactive at any given time. A CLMM lets providers choose a specific price range to supply liquidity in. This makes the capital more efficient, but requires active management to stay effective.
Can I lose money providing liquidity in a CLMM?
Yes. Liquidity providers in CLMMs are exposed to impermanent loss, which can be greater than in standard AMMs due to the concentrated nature of positions. If the market price moves outside your range, you hold only one asset and earn no fees. Fees earned may offset these losses over time, but this is not guaranteed.
What happens when my position goes out of range?
When the market price exits your chosen range, your position becomes entirely composed of one of the two tokens in the pair. You stop earning trading fees. You can either wait for the price to re-enter your range, or you can close your position and create a new one centered around the current price.
What is a tick in a CLMM?
A tick is one of the discrete price steps that CLMMs use to divide the price spectrum. Ticks function as the boundaries of a liquidity position. When you create a position, you select a lower tick and an upper tick. Your capital earns fees from all trades that occur between these two boundaries.
Where can I use a CLMM?
CLMMs are available on several decentralized exchange (DEX) protocols. Uniswap V3 and V4 are among the most widely used. Other protocols on various blockchains have adopted the same model. Always research the specific protocol, its fees, and associated risks before providing liquidity.
Closing Thoughts
Concentrated Liquidity Market Makers have made DeFi markets significantly more capital-efficient. They allow traders to access tighter spreads and deeper liquidity, while providers can earn higher fees on the same amount of capital.
That said, CLMMs transform liquidity provision from a passive activity into an active one. Managing price ranges, monitoring positions, and understanding impermanent loss are all part of the experience.
If you're new to DeFi, consider starting with standard AMM pools to get familiar with how liquidity provision works before moving to CLMMs.
Further Reading
Disclaimer: This content is presented to you on an "as is" basis for general information and or educational purposes only, without representation or warranty of any kind. It should not be construed as financial, legal or other professional advice, nor is it intended to recommend the purchase of any specific product or service. You should seek your own advice from appropriate professional advisors. Where the content is contributed by a third party contributor, please note that those views expressed belong to the third party contributor, and do not necessarily reflect those of Binance Academy. Digital asset prices can be volatile. The value of your investment may go down or up and you may not get back the amount invested. You are solely responsible for your investment decisions and Binance Academy is not liable for any losses you may incur. For more information, see our Terms of Use, Risk Warning, and Binance Academy Terms.