A study commissioned by decentralized exchange aggregator 1inch and conducted by Dune Analytics has found that approximately 85% of concentrated liquidity positions in decentralized finance are deployed inefficiently, resulting in an estimated $150 million in foregone annual fees across seven blockchain networks.
The research examined concentrated liquidity positions on major DeFi platforms, including Uniswap and its equivalents on various chains. Concentrated liquidity allows liquidity providers to allocate their capital within specific price ranges rather than across the full zero-to-infinity spectrum, theoretically enabling higher capital efficiency. However, the study found that the vast majority of these positions sit outside active trading ranges, earning little to no fees.
When a liquidity provider capital is placed in a concentrated range that the market price moves outside of, the position becomes inactive and stops accruing trading fees until the price returns to the specified range. The Dune research indicates that this occurs with most concentrated positions for significant portions of time, leading to the substantial underperformance captured in the study.
The findings highlight a persistent challenge in DeFi market making: while concentrated liquidity offers the potential for higher yields compared to full-range positions, it also requires active management and frequent rebalancing to remain effective. Passive liquidity providers who set concentrated ranges and leave them unattended are particularly vulnerable to this inefficiency.
1inch commissioned the research to illustrate the potential benefits of its active liquidity management solutions, which automatically adjust positions to keep capital within active trading ranges. The aggregator argues that automated management can significantly improve capital efficiency for liquidity providers who lack the time or expertise to manually monitor and rebalance their positions.
The $150 million figure represents fees that could have been earned had the underutilized capital been deployed more effectively. As DeFi continues to mature, solutions addressing this capital inefficiency are likely to become increasingly important for attracting and retaining liquidity providers.
This article was adapted from The Block. Read the original here.
