Module 3: DLMM Explained
What is DLMM?
DLMM (Dynamic Liquidity Market Maker) is an advanced form of automated market maker that allows liquidity providers to concentrate their capital within specific price ranges. This is an evolution from traditional AMMs where liquidity is spread across the entire price spectrum.
The key innovation of DLMM is that it allows liquidity providers to:
- Choose Price Ranges: Specify the price range where their liquidity will be active
- Increase Capital Efficiency: Concentrate capital where it's most likely to be used
- Customize Risk Exposure: Create strategies based on market expectations
- Earn Higher Fees: Potentially earn more fees per unit of capital deployed
Advantages over Traditional AMMs
DLMM offers several advantages compared to traditional constant product AMMs:
| Feature | Traditional AMM | DLMM |
|---|---|---|
| Capital Efficiency | Lower - capital spread across all prices | Higher - capital concentrated where needed |
| Fee Generation | Lower per unit of capital | Higher per unit of capital |
| Impermanent Loss | Always present when prices change | Can be managed with strategic positioning |
| Customization | Limited | Highly customizable strategies |
Concentrated Liquidity
Concentrated liquidity is the core concept behind DLMM. Instead of spreading liquidity across an infinite price range (from 0 to ∞), liquidity providers can focus their capital within a finite price range.
Example: Concentrated Liquidity
Consider a SOL/USDC pool:
- Traditional AMM: $10,000 of liquidity spread from $0 to ∞
- DLMM: $10,000 of liquidity concentrated between $80-$120
In the DLMM case, your effective liquidity within that range is much higher, potentially equivalent to having deposited much more in a traditional AMM.
Key benefits of concentrated liquidity:
- Higher Capital Efficiency: More trading volume per unit of capital
- Better Pricing: Deeper liquidity at relevant price points
- Customized Strategies: Ability to express market views through liquidity provision
Price Ranges and Strategies
When providing liquidity in a DLMM, you need to select a price range. This choice depends on your market outlook and risk tolerance.
Common Strategies:
- Wide Range (Passive):
- Set a wide price range around the current price
- Lower risk of going out of range, but lower capital efficiency
- Similar to traditional AMM but still more efficient
- Good for beginners or volatile markets
- Narrow Range (Active):
- Set a tight price range around the current price
- Higher capital efficiency and fee generation while in range
- Higher risk of going out of range, requiring repositioning
- Requires more active management
- Directional (Speculative):
- Set a range based on expected price movement
- Can be used to express bullish or bearish views
- Higher risk but potentially higher rewards
- Advanced strategy for experienced users
- Stablecoin Range:
- For stablecoin pairs, set a very narrow range (e.g., 0.99-1.01)
- Extremely capital efficient for assets that should maintain parity
- Lower impermanent loss risk
Out of Range Liquidity
When the market price moves outside your specified range:
- Your liquidity becomes "inactive" and stops generating fees
- Your position becomes 100% composed of one asset (the one with lower relative value)
- You'll need to adjust your range or wait for prices to return to your range
Example: Out of Range
If you provide liquidity for SOL/USDC in the range of $80-$120:
- If SOL price rises above $120, your position becomes 100% USDC
- If SOL price falls below $80, your position becomes 100% SOL
- In either case, you stop earning fees until the price returns to your range
Key Takeaways
- DLMM allows for concentrated liquidity within specific price ranges
- Concentrated liquidity is more capital efficient than traditional AMMs
- Different strategies (wide, narrow, directional) suit different risk profiles
- Out-of-range positions stop earning fees and require management
- Meteora is a leading DLMM protocol on Solana
In the next module, we'll provide a practical guide to using Meteora for liquidity provision.