Capital Efficiency in AMMs

Capital efficiency measures how much trading volume a protocol can support relative to the amount of capital deposited. Early AMM models were capital inefficient because liquidity was spread across an infinite price range, meaning much of it was never used.

Modern protocols use concentrated liquidity, allowing providers to allocate capital to specific price ranges where most trading occurs. This drastically increases the fees earned per unit of capital.

Improving capital efficiency is the primary driver of innovation in the decentralized exchange space. It allows for smaller, more agile protocols to compete with established giants.

High efficiency leads to lower costs for traders and higher returns for liquidity providers.