Price dynamics and risks

When new tokens are minted, they enter circulation at the acquisition price—the price the issuer paid to acquire the underlying asset. This acquisition price may differ from the current pool price determined by the CL AMM, creating price tension that must be resolved through market mechanisms.

Two scenarios emerge, each with different implications for market dynamics and fairness.

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Case A: Acquisition price above pool price

The scenario

The issuer acquires an asset at a price higher than the current pool price. New tokens enter at acquisition price $p^{\text{acq}} > p_t$ (current pool price).

What happens

This is the simple case. Market participants can acquire tokens at a discount from the pool (at $p_t$) compared to the acquisition price ($p^{\text{acq}}$). As demand absorbs the new supply, the pool price naturally converges upward toward the acquisition price.

Example: Pool price is $4,800 per token. Issuer acquires a new asset and mints tokens at $5,200 (acquisition price). Market participants can buy from the pool at $4,800, creating natural upward price pressure as demand absorbs supply.

Why it's straightforward

• No dilution risk: Existing token holders benefit as new supply validates higher valuations
• Natural price discovery: Market participants arbitrage the spread, driving pool price toward acquisition price
• No special mechanisms needed: Standard AMM dynamics handle price convergence

This scenario is bullish for existing token holders—new supply enters at a premium, validating the collection's value appreciation.

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Case B: Acquisition price below pool price

The scenario

The issuer acquires an asset at a price lower than the current pool price. New tokens enter at acquisition price $p^{\text{acq}} < p_t$ (current pool price).

What happens

This is the complex case that requires careful management. New supply enters below market, creating several risks:

1. Dilution risk

Existing token holders face dilution if new supply enters at a price below current market value. The pool's effective price must adjust downward to reflect the new supply, potentially triggering:

• Position losses for existing holders
• Liquidations in lending markets if token prices drop below collateral thresholds
• Panic selling as holders rush to exit before further dilution

2. Price impact risk

If all newly minted tokens are offered immediately at acquisition price, the sudden supply shock can cause:

• Sharp price drops as the pool absorbs new supply
• Disorderly execution of existing limit orders
• Front-running by sophisticated actors who anticipate the supply shock

3. Fairness risk

Without proper mechanisms, the minting process can create unfair advantages:

• Insiders who know about upcoming mints can position ahead of supply shocks
• Fast traders can extract value at the expense of slower participants
• Existing holders suffer dilution without adequate time to adjust positions

Formal structure

Let:

• $t_0$: mint time
• $p_t$: current pool price at time $t$
• $p^{\text{acq}}$: acquisition price
• $m$: number of newly minted tokens
• $S_t$: total circulating supply at time $t$

Dilution measure: The percentage drop in value per token if all new supply enters immediately:

$$\text{Dilution} = \frac{p_t - p^{\text{acq}}}{p_t} \times \frac{m}{S_t + m}$$

Example calculation:

• Current pool price: $p_t = 5{,}000$ USDC
• Acquisition price: $p^{\text{acq}} = 4{,}200$ USDC
• Newly minted tokens: $m = 1{,}000$
• Existing supply: $S_t = 10{,}000$ tokens

$$\text{Dilution} = \frac{5{,}000 - 4{,}200}{5{,}000} \times \frac{1{,}000}{10{,}000 + 1{,}000} = 0.16 \times 0.091 = 1.45\%$$

Existing token holders face a 1.45% dilution if all new supply enters immediately at acquisition price.

Price impact on the pool

If all $m$ tokens are sold into the pool at once, the price impact depends on the AMM's curve and available liquidity.

Note: Rarity uses a Concentrated Liquidity (CL) AMM, where liquidity is concentrated within specific price ranges. Price impact can be significantly different from traditional constant-product AMMs—either higher (if liquidity is thin at current price) or lower (if liquidity is deep). The example below uses a constant-product AMM to illustrate the concept, not to predict actual price impact.

For a constant-product AMM with reserves $(X, Y)$:

Before minting: Pool has $X$ tokens and $Y$ USDC, price $p_t = Y/X$

After selling $m$ tokens: Pool has $X + m$ tokens and $Y'$ USDC, price $p' = Y'/(X + m)$

The constant-product invariant gives: $(X + m) \cdot Y' = X \cdot Y$

Solving for $Y'$: $Y' = \frac{X \cdot Y}{X + m}$

USDC received: $\Delta Y = Y - Y' = Y \left(1 - \frac{X}{X + m}\right) = Y \cdot \frac{m}{X + m}$

Average execution price: $\bar{p} = \frac{\Delta Y}{m} = \frac{Y}{X + m}$

Price impact: $\frac{p_t - \bar{p}}{p_t} = \frac{m}{X + m}$

Example calculation (constant-product AMM):

• Pool reserves: $X = 10{,}000$ tokens, $Y = 50{,}000{,}000$ USDC
• Current price: $p_t = 5{,}000$ USDC per token
• Newly minted: $m = 1{,}000$ tokens

Price impact: $\frac{1{,}000}{10{,}000 + 1{,}000} = 9.09\%$

In this example, selling all 1,000 tokens at once would cause a 9.09% price drop, far exceeding the dilution effect alone. With a CL AMM, the actual impact could be higher (if liquidity is concentrated elsewhere) or lower (if liquidity is deep at current price).

Why this matters

Case B scenarios require careful management to ensure:

• Orderly price movement: Prevent sharp drops that trigger cascading liquidations
• Fair access: Give all participants adequate time to adjust positions
• Price discipline: Maintain alignment with objective asset value through mark-to-truth mechanisms

The protocol employs multiple mechanisms to handle Case B scenarios: hold periods, release curves, and open interest. Each mechanism addresses different aspects of the dilution, price impact, and fairness risks.

When price drops are healthy

It's important to note that price drops are not always negative. In fact, they can be healthy market corrections when the pool price is overvalued relative to objective asset value.

Healthy price drop scenarios:

• Pool overvaluation: If the pool price is $5,000 but objective NAV is $4,500, a drop to $4,500 is a correction, not a problem
• Buying opportunity: Market participants who believe in the collection's value see the drop as a discount to accumulate more tokens
• Regression to the mean: Prices naturally oscillate around fundamental value; drops bring overheated prices back to reality
• Price discovery mechanism: New supply entering below pool price is information—the issuer found assets cheaper than the market expected, signaling potential overvaluation

Price convergence to real-world value:

One of the key ways the protocol ensures pool prices reflect objective asset value is through the minting process itself. When issuers consistently acquire assets below pool price, it signals that:

1. The pool may be overvalued relative to real-world acquisition costs
2. Market participants should adjust their valuations downward
3. The collection's NAV per token should be recalculated based on new acquisitions

This feedback loop between off-chain acquisitions and on-chain prices is a feature, not a bug. It ensures that tokenized assets remain grounded in real-world economics rather than speculative bubbles.

The real concern: The protocol's supply management mechanisms are designed to prevent disorderly price movements (sharp drops, panic selling, cascading liquidations), not to prevent all price drops. If the market rationally concludes that the new acquisition price reflects fair value, the price adjustment will be welcomed as a healthy correction, and participants will view it as a buying opportunity rather than a crisis.

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Comparison summary

Aspect	Case A (acq > pool)	Case B (acq < pool)
Price pressure	Upward	Downward
Dilution risk	None (premium entry)	Yes (below-market entry)
Mechanisms needed	None (natural convergence)	Multiple (hold, release, open interest)
Holder impact	Positive (validation)	Negative (dilution)
Complexity	Simple	Complex

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Related reading

• Hold period mechanism for preventing immediate dumping
• Release curve mechanism for gradual supply entry
• Open interest mechanism for demand signals and capital
• Mark-to-Truth auctions for price convergence backstops