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CL AMM Primer

note

This is a general primer on Concentrated Liquidity AMMs and is not directly related to the Rarity protocol. Readers familiar with CL AMMs may skip this section.

Concentrated Liquidity Automated Market Makers (CL AMMs) are a fundamental evolution from traditional constant-product AMMs. Instead of spreading liquidity uniformly across all possible prices, CL AMMs allow liquidity providers to concentrate capital within specific price ranges, dramatically improving capital efficiency and reducing slippage.

For tokenized RWAs where prices should track objective NAV, this concentration is critical—most trading happens near fair value, making wide price ranges wasteful.

How CL AMMs work​

The basic concept​

In a traditional AMM (like Uniswap V2), liquidity is distributed uniformly from price 0 to infinity. If an asset trades between $4,800 and $5,200, most of the liquidity sitting at $1,000 or $10,000 is never used.

In a CL AMM, liquidity providers choose specific price ranges where their capital is active. A provider might concentrate liquidity between $4,800 and $5,200, earning fees only when the price is within that range but achieving much higher capital efficiency.

Price ranges and ticks​

CL AMMs divide the price space into discrete ticks—specific price points where liquidity can be added or removed. Liquidity providers deposit capital across a range of ticks, creating a position that's active only when the current price falls within that range.

Example: A liquidity provider deposits $100k of USDC and 20 RWA tokens to provide liquidity between $4,800 and $5,200 per token. As the price moves within this range:

  • Price rises: The position gradually sells RWA tokens for USDC
  • Price falls: The position gradually buys RWA tokens with USDC
  • Price exits range: The position becomes inactive (all one asset)

Current price and liquidity structure​

The CL AMM maintains a current price (the mid-price of the last trade). This price determines which liquidity ranges are active and how new liquidity can be added:

Above current price: Only sell liquidity (RWA tokens) can be added. These are effectively sell orders waiting for the price to rise.

Below current price: Only buy liquidity (USDC) can be added. These are effectively buy orders waiting for the price to fall.

At current price: Two-sided liquidity (both RWA tokens and USDC) is required. This is the only way to provide liquidity that's immediately active.

Key insight: You cannot add buy orders above the current price or sell orders below it in the standard CL AMM. This is why open interest (buy orders above price) requires a separate mechanism.

Capital efficiency​

The power of concentrated liquidity becomes clear when comparing capital requirements:

Traditional AMM example​

To provide $100k of liquidity in a constant-product AMM at price $5,000:

  • Requires $50k of USDC + $50k of RWA tokens (10 tokens)
  • Liquidity is spread from $0 to infinity
  • Most capital is idle, never earning fees

CL AMM example​

To provide equivalent depth between $4,800 and $5,200:

  • Requires $20k of USDC + $20k of RWA tokens (4 tokens)
  • 5x capital efficiency within the active range
  • All capital earns fees when price is in range

For RWAs: This efficiency is critical because professional market makers can provide deep liquidity with less capital, enabling tight spreads and better composability with lending and futures.

Liquidity provision dynamics​

Adding liquidity​

When a liquidity provider adds capital to a CL AMM, they specify:

  1. Price range: Lower and upper tick boundaries
  2. Capital amount: How much of each asset to deposit
  3. Fee tier: Which fee level to earn (e.g., 0.05%, 0.30%, 1.00%)

The AMM calculates the required ratio of assets based on the current price and chosen range. If the current price is within the range, both assets are required. If outside, only one asset is needed.

Earning fees​

Liquidity providers earn swap fees proportional to their share of liquidity in the active range. When a trade executes:

  1. The trade moves through active liquidity ranges
  2. Fees are distributed to all LPs in those ranges
  3. LPs earn more fees when their range is active and volume is high

Concentrated positions earn higher fees per dollar of capital because they're active more often within their chosen range.

Impermanent loss​

Like all AMMs, CL AMM liquidity providers face impermanent loss—the opportunity cost of holding assets in the pool versus holding them separately. The loss occurs when:

  • Price moves significantly in one direction
  • The LP's position rebalances (selling the appreciating asset, buying the depreciating one)
  • The LP would have been better off holding the original assets

CL AMM twist: Impermanent loss is amplified in concentrated positions because the rebalancing happens faster within a narrow range. However, higher fee earnings often compensate for this increased risk.

How trades execute​

Swapping through ranges​

When a user swaps tokens in a CL AMM, the trade executes against all active liquidity at the current price, then moves through subsequent ranges as needed:

  1. Start at current price: Execute against liquidity at the current tick
  2. Move to next range: If the trade exhausts current liquidity, move to the next price level
  3. Continue until filled: Keep moving through ranges until the entire trade is executed

Price impact: Large trades move through multiple ranges, experiencing different liquidity depths and increasing slippage. This is why depth-aware pricing (RWAP) matters—it captures the true cost of execution across ranges.

Example execution​

A user wants to buy 100 RWA tokens. Current price is $5,000.

  • Range 1 ($5,000–$5,050): 50 tokens available, average price $5,025
  • Range 2 ($5,050–$5,100): 30 tokens available, average price $5,075
  • Range 3 ($5,100–$5,150): 20 tokens available, average price $5,125

The trade executes across all three ranges, with an average execution price of $5,067 (vs. starting price of $5,000).

Why CL AMMs for Rarity​

The protocol uses CL AMMs because they provide:

  1. Capital efficiency: Professional market makers can provide deep liquidity with less capital
  2. Tight spreads: Concentrated liquidity reduces slippage for typical trade sizes
  3. Flexible positioning: Market makers can adjust ranges based on NAV expectations
  4. Depth visibility: On-chain liquidity depth enables RWAP and manipulation resistance
  5. Fee optimization: Higher fee earnings compensate for active management requirements

For tokenized RWAs where prices should track objective NAV and mark-to-truth auctions provide convergence backstops, CL AMMs are the ideal market structure.