CLMM

In recent years, decentralized finance (DeFi) has become one of the most talked-about topics in the blockchain industry. One of the most exciting developments in DeFi is the emergence of automated market makers (AMMs) that allow users to trade cryptocurrencies without needing a traditional order book or a centralized exchange. One of the most innovative types of AMMs is the Concentrated Liquidity Market Maker (CLMM), which was first proposed by Dan Robinson and introduced by the decentralized exchange Balancer in 2020. This article will explore what a CLMM is, how it works, and why it is gaining popularity in the DeFi space.
What is a Concentrated Liquidity Market Maker (CLMM)?
A CLMM is a type of automated market maker that allows liquidity providers to concentrate their assets in a small range of prices, rather than evenly across the entire price range. This means that the liquidity providers can provide more liquidity at specific prices, which makes it easier for traders to swap between assets at those prices. In other words, a CLMM provides deep liquidity at specific price points, rather than shallow liquidity across the entire price range.
To understand how a CLMM works, it is helpful to first understand how a traditional automated market maker (AMM) operates. In a traditional AMM, liquidity providers deposit two different assets (such as ETH and DAI) in equal amounts, and the AMM algorithm sets the price at which those assets can be traded based on the ratio of the two assets in the pool. For example, if the pool contains 100 ETH and 100 DAI, then the price of ETH would be 1 DAI per ETH. When a trader wants to buy ETH, they swap DAI for ETH at the current market price, which is determined by the AMM algorithm.
In contrast, a CLMM allows liquidity providers to deposit assets in any ratio they choose, rather than in equal amounts. For example, a liquidity provider could choose to deposit 90% of their assets in ETH and 10% in DAI, which would create a pool with concentrated liquidity at the price of 1 DAI per ETH. If a trader wanted to buy ETH at this price point, they could swap DAI for ETH and receive a better exchange rate than they would get in a traditional AMM, because there is more liquidity available at this price point.
How does a CLMM work?
A CLMM works by using a smart contract that implements a mathematical formula to calculate the exchange rate between two assets. The formula used in a CLMM is based on the constant product formula that is used in traditional AMMs, but it is modified to allow for concentrated liquidity. The formula takes into account the ratio of the two assets in the pool, as well as the amount of liquidity available at each price point.
When a trader wants to swap one asset for another, they send their assets to the CLMM smart contract, which calculates the exchange rate based on the current ratio of assets in the pool. The CLMM algorithm then uses the concentrated liquidity at specific price points to provide the best possible exchange rate for the trader. This means that traders can get better prices for their trades, especially at price points where liquidity is concentrated.
Why is CLMM gaining popularity in DeFi?
CLMM is gaining popularity in the DeFi space for several reasons. First, it allows liquidity providers to earn more fees by providing more liquidity at specific price points. Since traders are more likely to trade at these price points, the liquidity providers can earn more fees by providing deeper liquidity at these levels.
Second, CLMM provides better prices for traders, especially at price points where liquidity is concentrated. This makes it easier for traders to execute their trades and reduces the slippage they experience when trading large amounts of assets