In DeFi, concentrated liquidity is a strategy where liquidity providers (LPs) focus their assets on a specific price range within a decentralized liquidity pool (DEX). Instead of evenly distributing their assets across the entire price range, LPs can choose a custom range where they believe trading volume will be high, potentially earning higher fees.

Think of it like attending a marketplace. Instead of setting up a stall anywhere, you choose a specific location where you expect the most customers for your products. This way, you use your resources more efficiently and attract more buyers.

Here’s how it works:

Traditional DEX:

• LPs pool their assets (e.g., ETH and DAI) together.
• The DEX automatically sets the price based on the total pool size and trading activity.
• Trading occurs freely within the entire price range.
• LPs earn fees proportional to their contribution to the pool.

Concentrated DEX:

• LPs can choose a specific price range (e.g., $100-$120) to provide liquidity.
• Their assets are only used for trades happening within that chosen range.
• In exchange for their targeted contribution, LPs potentially earn higher fees.

Benefits:

• Increased capital efficiency: LPs can optimize their returns by focusing on potentially high-volume price ranges.
• Reduced slippage: Traders experience less price impact when trading within a concentrated pool.
• Flexibility: LPs can customize their exposure to different price ranges based on their risk tolerance and market expectations.