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When a trader executes a transaction, they may deposit, for example, $1,000 worth of ETH into the pool and take out about $995 worth of BTC. The $5 fee from this transaction goes to the liquidity providers in the form of ETH tokens. This simple mechanism allows for seamless conversions between assets and encourages the continuous flow of liquidity.
The Concept of Concentrated Liquidity
While the basic model of liquidity pools is straightforward, things become more intricate with the introduction of concentrated liquidity. This allows liquidity providers to position their assets within a specific price range rather than covering all potential prices from zero to infinity.