Active Liquidity

When the price of an asset goes up or down, it might go beyond the specific price range set by Liquidity Providers (LPs) for a position. If this happens, the liquidity in that position becomes inactive, and it stops making fees. In simple terms, when the price moves out of the allowed range, the position can't earn fees anymore.

As the price goes in a certain direction, Liquidity Providers (LPs) acquire more of one asset because swappers are seeking the other asset. This continues until all of their liquidity is composed of just one asset. This behavior is not commonly observed in version 2 because LPs usually don't reach the extreme upper or lower price bounds (i.e., 0 and ∞) of the two assets. If the price reenters the specified range, the liquidity becomes active again, and LPs within the range start earning fees once more.

LPs (liquidity providers) have the freedom to create multiple positions with different price intervals. Concentrated liquidity allows the market to determine a reasonable distribution of liquidity. Rational LPs are motivated to focus their liquidity in specific areas while ensuring that it stays active. This mechanism encourages LPs to make strategic decisions for the benefit of the market.