Concentrated Liquidity Explained
The cornerstone of decentralized finance are Automated Market Makers (AMM) — they allow traders to exchange tokens directly through smart contracts, bypassing any centralized intermediary. Instead of relying on the depth of the market (DOM) used on centralized exchanges, decentralized exchanges rely on pools of tokens. The main point of AMM comes down to the fact that liquidity providers contribute tokens to the pool, receiving commissions (or fees) from traders' transactions.
There are many different types of AMM, each with its advantages and disadvantages. However, by far the most popular type of AMM is the Constant Product Market Maker (CPMM).
CPMM is based on the X*Y=K function, which sets the price range for two tokens depending on the available liquidity for each of them. When the supply of token X increases, the supply of token Y decreases, and vice versa. The graph of this AMM has the form of a hyperbola, where liquidity in the pools is always available:
Source: Dmitriy Berenzon
The most popular AMM of this type is Uniswap. It was Uniswap that successfully implemented the decentralized liquidity pools idea. Thus, as an example, Uniswap V2 allows you to create pools using any ERC-20 tokens, and the provided liquidity is spread equally among all the providers involved across the entire price range. This implementation of AMM, despite all the advantages, has one disadvantage such as the inefficient use of capital. So, the liquidity provided to the DAI/USDC pool uses only about 0.5% of the total capital provided by LP, because the range of price movement within this pair fluctuates between $0.99 and $1.01.
In order to increase the efficiency of the provided capital, in March 2021 Uniswap announced its third version of the code, which was launched on May 5 of the same year.
In Uniswap V3, users were able to provide liquidity for certain price ranges, minting their LPs individual non-fungible (NFT) tokens. These individual LP tokens are combined into a single pool, forming combined liquidity, so called pool depth. This technology is known as “concentrated liquidity”. The advantages of concentrated liquidity can be seen on the example of a volatile pair (ETH/DAI):
.png)
Ada and George want to provide liquidity to the ETH/DAI pool on Uniswap v3. They have $1 million each. Let's assume the current price of ETH is 1,500 DAI.
Ada decides to allocate her capital across the entire price range (as she would do in Uniswap v2). She is hosting 500,000 DAI and 333.33 ETH, for a total of $1 million.
George instead creates a concentrated position by placing funds only in the price range of 1,000 to 2,250 DAI per 1 ETH. He deposits 91,751 DAI and 61.17 ETH for a total of around $183,500. He keeps the remaining $816,500 for himself, investing it as he sees fit.
Of course, this increased return is not free in terms of risk assessment. The narrower the range of liquidity provision, the more impermanent losses the liquidity provider may face. Therefore, providing liquidity remains a serious challenge. It is necessary to take into account price ranges, commission rates and risks of impermanent loss. According to some studies, half of all LP providers on Uniswap V3 suffer from non-permanent losses.
Concentrated Liquidity Market Makers (CLMMs)
The AMM's active development with concentrated liquidity served as an impetus for the evolution of a fundamentally new market — the market for solutions that provide services for the active management of LP positions. Such protocols are called “Concentrated Liquidity Market Makers”. Today, the market is represented by dozens of projects, and the total TVL of the sector is estimated at $312M:
.png)
Source: DefiLlama
CLMMs provide tools that allow users to take advantage of the automatic rebalancing of positions to keep them within acceptable limits. In addition, such protocols increase the efficiency of investment strategies by auto-compounding of the received commissions. Such projects are designed to greatly simplify the management of provided liquidity on decentralized exchanges.
One of the undisputed market leaders is Gamma.
What Is Gamma Protocol?
Gamma is a non-custodial protocol designed to actively manage concentrated liquidity pools. The core feature behind the project is Hypervisor. It contains a set of functions allowing rebalancing, position setting, and fee processing. These features empowers Hypervisor to actively manage the funds in the liquidity pool. In a number of decentralized exchanges, when providing liquidity, it is necessary to observe a 50/50 ratio between tokens. In turn, the Hypervisor structure allows you to place liquidity that differs from the specified proportions.
Gamma helps liquidity providers to issue liquidity in protocol-supported pools to actively manage their positions and earn returns. To date, the project's TVL is $90M, and the protocol itself is represented in many networks: Polygon, Polygon zkEVM, Arbitrum, BSC, Optimism, Ethereum, Linea, Moonbeam, Celo, Mantle, Avalanche, Fantom and Rollux. Gamma also supports a number of leading exchanges:
Exchange | TVL | Total Pairs |
Thena | $28,58M | 143 |
QuickSwap | $28,26M | 116 |
Uniswap | $13,04M | 115 |
Retro | $6,35M | 28 |
Zyberswap | $667,21K | 15 |
Ramses | $456,36K | 27 |
Sushi | $34,98K | 28 |
Gamma is based on a number of strategies that allow you to maximize profitability and minimize impermanent losses. Strategies are automated and use various triggers to execute the appropriate actions. Let’s overview the main types of strategies used in the protocol.
Dynamic Range (Wide & Narrow)
This type of strategy is involves set liquidity ranges for the pair. These ranges change automatically when certain rebalancing triggers are reached. For example, when the price changes by a certain percentage. Fee income received is reinvested, which in turn allows the liquidity provider to obtain higher returns.
.png)
Stable
This strategy is used for stablecoins. Liquidity ranges are aimed to straddle one asset at various ranges depending on backtesting results. The more volatile the stablecoin pair, the wider the used range. Commissions generated by the position are reinvested in the liquidity pool.
.png)
Pegged Price
The folowing type of strategy is used for pegged assets. Liquidity is provided directly around the net asset value of a provided asset. As soon as the net asset value gets certain price targets, the liquidity position is be automatically rebalanced.
.png)
Gamma Tokenomics
The project's native token is $GAMMA. The main utility of the token is staking. All vaults Gamma - generate commissions for liquidity providers. Some of these fees go to liquidity providers, while the rest is shared among $GAMMA stakers. In this way, Gamma allows users to earn from pools of liquidity without having to provide that liquidity to the pools. The representation of staked $GAMMA tokens is xGAMMA.
The distribution of tokens goes the following way:
.png)
Source: Gamma
The total supply is 100,000,000 tokens, of which 58.72% is in Circulating Supply.
GAMMA offers LP position management solutions for both individual investors and enterprises such as web3 projects and DAOs. So, Gamma allows projects to earn returns on assets from their treasuries, as well as an opportunity to use this income for grants.
GAMMA has several investors who have supported the project. These include Blockchain, Capital, Electric Capital, 1confirmation, and others:
.png)
Source: Gamma
Gamma has repeatedly passed audits from a number of companies, such as: Consensys Diligence, Arbitrary Execution, Omniscia, CertiK. In addition, the project launched a bug bounty program on Immunefi.
How to Interact With Gamma on Notum?
Notum provides you with an opportunity to become a liquidity provider in Gamma pools and get commissions for doing that.
.png)
Source: Gamma
To invest your funds, you need to:
Go to the "Investments" section;
Select the Gamma protocol in the "Filters" section;
Go to the page of any pool to read the description of the strategy, assets, and key indicators.
The investments are extremely easy to follow, all you need to do is connect your wallet and select an asset you will enter the position with.
Closing Thoughts
The emergence of concentrated liquidity has greatly increased the efficiency of the way to use capital through the opportunity to establish tailored price ranges. However, along with this, the complexity of providing liquidity for ordinary users has also grown — there is a need for optimal and timely management of LP positions. The so-called Concentrated Liquidity Market Makers help in solving these problems, and the leader in this field is Gamma.
Gamma is a leading provider of concentrated liquidity management solutions. The protocol allows liquidity providers to effectively use the provided capital, while not wasting time and effort on monitoring and managing positions on their own. The advantages of Gamma are that the protocol allows automatic rebalancing of positions to maintain them within a given range, as well as automatic reinvestment of generated commissions to maximize profitability. Gamma uses a number of strategies to achieve these goals. Each of these strategies targets specific asset classes.
Today, Gamma is an entire ecosystem for managing concentrated liquidity in DeFi. The project supports a number of leading decentralized exchanges operating on a concentrated liquidity model.
At the same time, with the advent of Uniswap V4, Algebra V2, and Balancer V2, concentrated liquidity will reach a new level, and Gamma will continue to provide advanced strategies for both B2C and B2B.
Follow us on Twitter | Mirror | Discord | Blog
Disclaimer: Notum does not provide any investment, tax, legal, or accounting advice. This article is written for informational purposes only. Cryptocurrency is subject to market risk. Please do your own research and trade with caution.