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Liquidity Management

Liquidity management is the art of ensuring that tokenized RWAs have deep, efficient markets with tight spreads and sufficient capacity for large trades. Unlike liquid crypto assets where liquidity emerges organically, RWAs require professional market makers who actively manage positions, adjust ranges, and provide consistent depth.

The design goal is straightforward: create markets that feel liquid despite the underlying assets being rare and illiquid. This requires professional market making, protocol incentives, and mark-to-truth backstops that ensure prices stay anchored to fundamentals.

The challenge of RWA liquidity​

Tokenized RWAs face unique liquidity challenges:

Low natural liquidity: Unlike ETH or BTC, RWAs don't have thousands of traders providing organic liquidity. The underlying assets (luxury watches, real estate, collectibles) are inherently illiquid.

Price uncertainty: Without liquid reference markets, determining fair value is difficult. Is a tokenized FP Journe worth $5,000 or $5,500? Market makers need external information.

Thin order books: Small trades can cause large price swings if liquidity isn't actively managed. This creates poor UX and limits composability with lending/futures.

Impermanent loss risk: Professional market makers face significant impermanent loss if prices move unexpectedly, requiring compensation through fees or protocol incentives.

Professional market makers​

The protocol expects professional market makers to provide the majority of liquidity. These are sophisticated actors with:

High-frequency information​

Market makers have real-time information about off-chain asset markets:

  • Recent auction results for comparable items
  • Dealer quotes and OTC market activity
  • Appraisal updates and condition reports
  • Macroeconomic factors affecting asset classes

This information enables them to price accurately and adjust positions before the broader market reacts.

Capital efficiency​

Professional market makers use concentrated liquidity positions to maximize capital efficiency:

  • Tight ranges around expected fair value
  • Active rebalancing as prices move
  • Multiple positions at different price levels
  • Hedging strategies to reduce impermanent loss

Example: A market maker might provide $500k of liquidity in a $4,900–$5,100 range (±2% around $5,000), earning high fees while maintaining tight spreads.

Active management​

Market makers actively manage their positions:

  • Range adjustments: Move liquidity as NAV expectations change
  • Spread management: Widen spreads during volatility, tighten during calm periods
  • Inventory control: Rebalance to avoid becoming too long or short
  • Risk management: Reduce exposure during uncertain periods

This active management ensures that liquidity is always available where it's needed, not stuck in outdated ranges.

LP positioning strategies​

Professional market makers use layered liquidity structures to balance capital efficiency, fee revenue, and risk management. The goal is to earn consistent fees while avoiding mark-to-truth auction triggers that signal mispricing.

Core tight band (±50-100 bps): 40-60% of capital

This is where most trading happens. Market makers concentrate the majority of their liquidity in a tight band around fair value to maximize fee revenue.

Benefits:

  • High capital efficiency: Earns fees on nearly every trade
  • Tight spreads: Improves user experience and attracts volume
  • Maximum fee capture: Active on both sides of most transactions

Risks:

  • High impermanent loss: Vulnerable if price moves suddenly
  • Requires constant monitoring: Must rebalance frequently as price drifts
  • Inventory risk: Can accumulate large one-sided positions quickly

When to use: When the market maker has high confidence in current fair value and expects low volatility. Best for mature collections with stable valuations.

Mid-range bands (±150-250 bps): 30-40% of capital

Secondary positions at wider ranges act as backstops for larger price movements and provide ongoing fee revenue during moderate volatility.

Benefits:

  • Reduced monitoring: Doesn't require constant rebalancing
  • Volatility capture: Earns fees during price swings
  • Inventory buffer: Provides liquidity for larger trades without depleting core position

Risks:

  • Lower fee revenue: Only active during price moves
  • Moderate IL exposure: Still vulnerable to sustained directional moves
  • Capital inefficiency: Sits idle during normal trading

When to use: Always. These bands provide insurance against sudden volatility and ensure continuous liquidity even during price discovery periods.

Wide safety bands (±400-700 bps): 10-20% of capital

Thin liquidity at extreme ranges serves as tail risk protection and captures fees during crisis scenarios.

Benefits:

  • Crisis revenue: Earns exceptionally high fees during panics or surges
  • Backstop liquidity: Prevents total liquidity breakdown
  • Low maintenance: Rarely needs adjustment
  • Asymmetric payoff: Small capital allocation, large potential fee capture

Risks:

  • Capital drag: Usually sits completely idle
  • Extreme IL: If price reaches these levels, significant losses likely
  • Potential loss indicator: Activation suggests serious mispricing

When to use: Allocate a small portion always. Think of it as "volatility insurance" that occasionally pays out.

Capital allocation example​

For a market maker with $1M in capital providing liquidity around a $5,000 fair value:

Core band:   $500k at $4,900-$5,100 (±2%)    → High fee revenue
Mid bands:   $200k at $4,850-$4,900 (bid side)
             $200k at $5,100-$5,150 (ask side)  → Volatility capture
Safety:      $50k at $4,700-$4,850 (bid tail)
             $50k at $5,150-$5,300 (ask tail)   → Crisis protection

Expected behavior: The core band earns fees on 80-90% of trading volume. Mid bands activate during 10-15% of periods. Safety bands trigger only during extreme moves (1-2% of the time).

Asymmetric positioning when mispriced​

Critical principle: If you know the pool price is wrong, don't provide symmetric liquidity. Use asymmetric positioning to gently guide price toward fair value while earning fees.

Scenario 1: Pool overvalued (spot $5,200, fair value $5,000)​

Problem: Providing symmetric liquidity around $5,200 reinforces the mispricing and risks a mark-to-truth auction.

Solution: Asymmetric positioning to encourage downward price discovery

Heavy ask-side liquidity: $600k at $5,150-$5,250
Light bid-side liquidity:  $200k at $5,100-$5,150
Bid anchor near fair:      $200k at $4,950-$5,050

Mechanism: Heavy ask-side liquidity makes it easy for traders to sell, pushing price down. Light bid-side liquidity doesn't support the inflated price. Bid anchor at fair value provides a "floor" where you're willing to accumulate.

Why this works:

  • Natural convergence: Price drifts down through normal trading
  • Profitable rebalancing: You sell tokens at inflated prices ($5,150-$5,250) and buy them back cheaper ($4,950-$5,050)
  • Avoids auction trigger: Gradual convergence prevents anyone from triggering a mark-to-truth auction
  • Defensible positioning: You're providing liquidity, just asymmetrically based on your fair value assessment

Risks:

  • Wrong about fair value: If you're wrong and fair value is actually $5,200, you'll accumulate a large short position and face losses
  • Opportunity cost: Lighter liquidity earns fewer fees in the short term
  • Competitor undercut: Another MM providing symmetric liquidity at $5,200 may capture more volume

Scenario 2: Pool undervalued (spot $4,800, fair value $5,000)​

Problem: Pool is trading cheap relative to fundamentals.

Solution: Asymmetric positioning to encourage upward price discovery

Heavy bid-side liquidity: $600k at $4,750-$4,850
Light ask-side liquidity:  $200k at $4,850-$4,950
Ask anchor near fair:      $200k at $4,950-$5,050

Mechanism: Heavy bid-side liquidity absorbs selling pressure and supports price increases. Light ask-side doesn't resist upward moves. Ask anchor at fair value is where you're willing to distribute.

Why this works:

  • Profitable accumulation: You buy tokens cheap ($4,750-$4,850) and sell them higher ($4,950-$5,050)
  • Natural support: Your buying pressure prevents further decline
  • Auction protection: Gradual convergence avoids triggering RECENTER

Risks:

  • Wrong about fair value: If fundamentals have actually deteriorated, you accumulate a large long position at falling prices
  • Capital constraints: Need significant capital to absorb downward pressure
  • Adverse selection: Other informed traders might know something you don't

Avoiding mark-to-truth auctions​

Market makers have strong incentives to prevent mark-to-truth auctions:

Why auctions are costly for MMs:

  1. Trading halt: Brief trading pause during RECENTER (minutes) means no fee revenue
  2. Forced repositioning: If RECENTER occurs, protocol liquidity moves to new mark. Your positions may go idle (out of range), requiring expensive rebalancing
  3. Adverse selection: Auction discovery that contradicts your positioning means you were on the wrong side of the trade
  4. Temporary friction: Post-RECENTER flow caps (2-3% TVL/day) and temporary fees (10-20 bps) reduce trading volume and your fee revenue
  5. Reputation risk: If your MM firm consistently positions at wrong prices, you lose credibility

Prevention strategies:

Monitor off-chain indicators aggressively​

Track real-time market signals that might move fair value before they're reflected on-chain:

  • Comparable asset auctions (Christie's, Sotheby's, RM Sotheby's results)
  • Dealer quotes and OTC market activity
  • Condition reports and appraisal updates
  • Macroeconomic shifts (interest rates, luxury demand trends)
  • Collection-specific news (authentication issues, provenance discoveries)

Adjust positioning immediately when these signals suggest fair value has moved.

Use TWAP/RWAP as your guide​

Since protocol functions (lending LTVs, minting) use TWAP/RWAP, these represent the "official" price the system sees. If spot price is far from TWAP:

  • Spot > TWAP: Pool is running hot → add ask-side liquidity to cool it down
  • Spot < TWAP: Pool is running cold → add bid-side liquidity to warm it up

Why this matters: Large divergences between spot and TWAP signal potential mispricing that could trigger auction calls.

Preemptive rebalancing​

If you believe fair value has shifted (e.g., from $5,000 to $4,800), don't wait for a auction trigger:

  1. Remove old liquidity from outdated ranges
  2. Add asymmetric liquidity to guide price toward new fair value
  3. Communicate reasoning (if applicable) through social channels or governance forums
  4. Monitor convergence and adjust positioning as price moves

Goal: Let the market discover the new price through natural trading, not through forced auction mechanics.

Coordinate with other MMs (carefully)​

If multiple sophisticated MMs agree fair value has moved:

  • Independent repositioning by multiple MMs creates strong price signals
  • Avoid explicit collusion on prices (potential legal/regulatory issues)
  • Share information about off-chain market conditions that justify repositioning

Natural coordination: Multiple MMs independently reviewing the same off-chain data (auction results, dealer quotes) and independently adjusting positions achieves convergence without coordination.

Know the trigger thresholds​

Understand when auctions become likely:

  • Cooldown period: Typically 24-72 hours between auctions → safe window after recent auction
  • Caller bond: $25k minimum → significant barrier to frivolous calls
  • Healthy band (ε1\varepsilon_1): ±30-40 bps → if pool is within this band of fair value, CONFIRM is likely (caller gets slashed)
  • Recenter threshold: ~40+ bps sustained deviation → auction becomes profitable to trigger

Safe zone: Keep spot price within ±30 bps of where you believe fair value is, and ensure TWAP stays within ±40 bps of fair value.

Risk management best practices​

Position limits: Never allocate more than you can afford to lose if fair value moves sharply. Typical allocation: 50-70% of available capital, keeping 30-50% in reserve.

Rebalancing discipline: Set clear rules for when to adjust ranges:

  • Inventory skew > 70/30 → rebalance
  • Out of range > 30% of position → move ranges
  • Fair value shift > 20 bps → adjust asymmetric positioning

Hedging: Consider hedging large one-sided inventory accumulation:

  • Options: If available, use options to hedge tail risk
  • Cross-collection: Offset long position in one collection with short in correlated collection
  • Stablecoin buffer: Maintain adequate stablecoin reserves to rebalance without external funding

Stress testing: Model scenarios where fair value moves ±5%, ±10%, ±20%:

  • What's your impermanent loss?
  • Can you cover inventory with reserves?
  • At what point do you exit entirely?

When to exit entirely​

Sometimes the best move is to withdraw all liquidity:

Exit signals:

  • Loss of information edge: No longer confident in fair value assessment
  • Extreme volatility: IL risk exceeds potential fee revenue
  • Governance issues: Collection management becomes unreliable
  • Liquidity crisis: Other MMs exiting, suggesting systemic problems
  • Regulatory concerns: Legal/compliance issues emerging

Clean exit: Remove liquidity during calm periods (low volume) to minimize market impact. Avoid exiting during volatility when your liquidity is most valuable (and most profitable).

Trust minimization​

While professional market makers provide essential liquidity, the protocol doesn't fully trust them. Multiple mechanisms ensure that market makers cannot manipulate prices or extract unfair value:

Mark-to-Truth backstop​

If market makers push prices away from objective NAV, mark-to-truth auctions create arbitrage opportunities that converge price back to fundamentals. This limits how far market makers can deviate from fair value before being arbitraged.

Example: Market maker pushes price to $5,500 when NAV is $5,000. Mark-to-Truth auction offers tokens at $5,050 (NAV + 1% premium), enabling arbitrageurs to buy at $5,050 and sell at $5,500, collapsing the mispricing.

TWAP/RWAP smoothing​

Protocol-critical functions (lending LTVs, liquidations, minting floors) use TWAP and RWAP instead of spot price. This means market makers cannot manipulate these functions with momentary price spikes—they would need to sustain manipulated prices for extended periods, which is economically infeasible.

Competitive market making​

The protocol is permissionless for liquidity provision. Anyone can provide liquidity, creating competition among market makers. If one market maker charges excessive spreads or provides poor depth, others can undercut them and capture fee revenue.

Issuer market making​

The issuer acts as a fallback market maker using their liquidity reserves (10% of assets + 10% of funds raised). This ensures that even if professional market makers exit, basic liquidity remains available.

Protocol incentives​

To attract and retain professional market makers, the protocol provides several incentives:

Trading fees​

Market makers earn swap fees proportional to their liquidity provision. In CL AMMs, concentrated positions earn higher fees per dollar of capital because they're active more often within their chosen range.

Fee tiers: Different pools may have different fee tiers (e.g., 0.05%, 0.30%, 1.00%) based on asset volatility and expected volume. Higher fees compensate for higher risk.

Profit-sharing from supply management​

Some supply management mechanisms (release curves, open interest, Dutch auctions) generate surplus when tokens sell above acquisition price. This surplus can be distributed to liquidity providers, creating additional yield beyond trading fees.

See Coordinated supply management for details on profit-sharing structures.

Liquidity depth targets​

The protocol aims for specific liquidity depth targets based on collection size and expected trading volume:

Collection SizeTarget Depth (±2%)Target Spread
$1M–$10M$100k–$500k0.5%–1.0%
$10M–$50M$500k–$2M0.3%–0.5%
$50M+$2M+0.1%–0.3%

Target depth: Liquidity available within ±2% of current price, enabling large trades with minimal slippage.

Target spread: Difference between best bid and best ask, indicating market tightness.

These targets ensure that collections have sufficient liquidity for composability with lending and futures while maintaining tight spreads for good UX.

Monitoring and intervention​

The protocol monitors liquidity health through on-chain metrics:

Liquidity depth​

Total liquidity available within ±2%, ±5%, and ±10% of current price. Tracks whether depth is sufficient for expected trading volume.

Spread width​

Difference between best bid and best ask. Wide spreads indicate poor liquidity or high uncertainty.

Volume-to-liquidity ratio​

Daily trading volume divided by average liquidity. High ratios indicate that liquidity is insufficient for trading demand.

RWAP deviation​

Difference between spot price and RWAP. Large deviations indicate thin liquidity at current price.

Intervention mechanisms​

If liquidity falls below targets, the protocol can:

  1. Trigger mark-to-truth auction: If poor liquidity is due to mispricing, converge to NAV
  2. Issuer intervention: Issuer deploys additional reserves to stabilize markets
  3. Increase fee tiers: Temporarily raise trading fees to attract more LP capital
  4. Pause risky features: Temporarily disable high-leverage futures or aggressive lending LTVs

Liquidity lifecycle​

Liquidity evolves through different phases as a collection matures:

Phase 1: Bootstrapping (Raredrop)​

  • Issuer-only liquidity: Issuer provides all initial liquidity at acquisition value
  • Controlled environment: No external liquidity, predictable depth
  • Goal: Establish initial price discovery and distribution

Phase 2: Post-launch​

  • Issuer + early LPs: Issuer deploys reserves, early LPs enter
  • Initial fee revenue: Trading fees and profit-sharing from supply management
  • Goal: Transition from issuer-only to multi-LP liquidity

Phase 3: Maturity​

  • Professional market makers: Sophisticated actors provide majority of liquidity
  • Organic fee revenue: Trading fees and profit-sharing sustain liquidity
  • Goal: Self-sustaining, deep markets with tight spreads

Phase 4: Scale​

  • Multiple market makers: Competition drives tight spreads and deep liquidity
  • Composability: Sufficient depth for lending, futures, and other DeFi primitives
  • Goal: Institutional-grade liquidity comparable to traditional markets

Why this matters​

Liquidity is the lifeblood of any market. Get it wrong and you have:

  • Poor UX: Wide spreads and high slippage frustrate users
  • Limited composability: Lending and futures can't function without deep liquidity
  • Price manipulation: Thin liquidity enables attacks and unfair extraction
  • Death spiral: Poor liquidity drives users away, making liquidity even worse

Get it right and you have:

  • Tight spreads: Users get fair execution on every trade
  • Deep markets: Large trades execute with minimal slippage
  • Composability: Lending and futures can offer competitive parameters
  • Virtuous cycle: Good liquidity attracts more users, generating more fees, attracting more LPs

Professional market making, protocol incentives, and mark-to-truth backstops work together to create sustainable, deep liquidity for tokenized RWAs.