Modulis 4 · Concentrated liquidity

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AMM basics — how automated exchanges work

Video · 3 min.

AMM basics

Ethan swaps SOL for USDC at 3 a.m. with nobody on the other side. How an AMM works like a vending machine, what a liquidity pool and an LP are, why the old model leaves most of the money asleep, and how concentrated liquidity changes that.

Narrated, with light music

The full lesson with numbers and rules is below.

Watch on YouTube

After this module

You'll learn to provide liquidity yourself and earn trading fees — becoming a "mini exchange owner" instead of just a user. You'll understand how concentrated liquidity works, and how to deliberately pick the price range where your money works hardest.

What is an AMM?

AMM (Automated Market Maker) is like an automatic currency exchange machine. Drop in one currency — get another out. It's always open, no need to wait for another person.

A currency exchange analogy

Remember currency exchange booths at the airport? You show up with euros, get dollars back. The booth is always ready — because it already holds money. An AMM works exactly the same way, just online and with crypto.

AMM vs Order Book

Order Book (Binance, NYSE): buyers and sellers post their prices. Someone else has to agree to your price. Like a marketplace.

AMM (Uniswap, Orca): the money is already sitting in a "pool". A formula sets the price automatically. You can swap any time, no waiting. Like a vending machine.

How Order Book and AMM differ

	Order Book	AMM
How the price is set	People's orders	A math formula
Who provides the money	Professional market makers	Anyone (an LP)
Runs 24/7	Depends on participants	Yes, always
Capital needed to start	A lot	Any amount
Speed	Milliseconds (centralized)	Block time (1–12 sec)

The old model — x * y = k

The first AMM formula (Uniswap V2) was very simple:

x * y = k

Where:

x = the amount of one token in the pool (e.g., SOL)
y = the amount of the other token in the pool (e.g., USDC)
k = a constant (always stays the same)

Example: the pool holds 1,000 SOL and 100,000 USDC. Price = 100,000 / 1,000 = $100 per SOL.

The problem: most of the money does nothing

An employee analogy

Imagine you have 20 employees. But only 1 actually works. The other 19 just sit around waiting "in case they're needed someday." That's the old AMM model — your money is spread from $0 to infinity, but only about 5% of it actually works.

In the old model, your money "works" from $0 to infinity. But the SOL price fluctuates, say, between $60 and $120. Most of that money just sits there doing nothing.

Concentrated Liquidity — the revolution

In 2021, Uniswap V3 introduced concentrated liquidity — a new idea. Instead of your money working everywhere, it works only where most of the trading actually happens.

A marketplace analogy

Instead of setting up your market stall all over the city (with most spots standing empty), you set it up right in the center of the market, where most of the buyers walk by. Less space, but far more sales.

Model	Where the money works	Efficiency	Income
Old (V2)	$0 → infinity	~5% working	Small
New (V3)	$64 → $120	~80% working	Much bigger

How this works

Instead of spreading $100,000 from $0 to infinity, you say: "I'm only providing liquidity between $80 and $100."

Result:

Your $3,200 concentrated position ($64–$88) = like $50,000+ in the old model
Income only comes in while the price is inside your range
Once the price leaves — the income stops

An efficiency example

Capital	Model	Equivalent	Efficiency
$3,200	Concentrated ($64–$88)	~$50,000 old-style	15.6x
$10,000	Concentrated ($80–$100)	~$200,000 old-style	20x
$50,000	Old-style ($0–infinity)	$50,000	1x

What is an LP (liquidity provider)?

LP (Liquidity Provider) — a person who puts their money into an AMM pool. In exchange, they receive a share of the fee from every swap.

LP = a mini exchange owner

By providing liquidity, you become an exchange owner. Every time someone swaps SOL for USDC through your pool — you get a cut of the fee. Like a store markup — a slice of it goes to you.

There's also one trade-off worth understanding: Impermanent Loss — when the price moves, the makeup of your position changes. That's not a surprise, it's a known, calculable quantity: you can estimate it in advance and manage it by choosing your price range carefully. Exactly how to calculate and compensate for it — that's a separate lesson, 4-6.

How it works:

The LP deposits money into the pool (e.g., SOL + USDC)
People swap currencies through that pool
Every swap pays a fee (0.01%–1%)
The LP receives a share of the fee, proportional to their deposit

Where does Concentrated Liquidity operate?

Protocol	Network	Model	Swap cost
Uniswap V3/V4 ETH	Ethereum / Arbitrum	Tick-based	~$0.03–$0.30 (mainnet), <$0.05 (L2)
Orca Whirlpool SOL	Solana	Tick-based	<$0.01
Meteora DLMM SOL	Solana	Bin-based	<$0.01
Raydium CLMM SOL	Solana	Tick-based	<$0.01

In this module we'll dig into Uniswap ETH, Orca SOL, and Meteora SOL in detail — the three main protocols.

Why does this matter for our strategies?

In our strategies, concentrated liquidity is one of the main income sources:

Strategy A: ~2/3 of borrowed USDC goes into LP
Strategy B: the USDC position generates ~68% APR from fees (a point-in-time figure for the example position)
LP income covers the cost of insurance and debt

Without concentrated liquidity's efficiency, these strategies simply wouldn't work. The old LP model wouldn't generate enough income.

Key terms for this module

Term	Meaning
AMM	Automated Market Maker — a program that swaps currencies
LP	Liquidity Provider — a person who puts money into a pool
Pool	The reserve where both tokens are held
Range	The price interval where your money is working
Fee Tier	The fee size (0.01%, 0.05%, 0.30%, 1.00%)
Tick	The smallest price increment in the system
IL	Impermanent Loss — the potential loss from a price change

Next up: We'll start with Uniswap V3 — the protocol that first created concentrated liquidity.

Quick check

How does an AMM differ from an Order Book?

Practice task

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Get familiar with real LP pools

Theory's clear — now go see what AMM pools actually look like in the real world. Takes about 10 minutes, no money required — just exploring.

In this task we're ONLY looking — don't open any position, and you don't need to connect a wallet. Orca runs ONLY on the Solana network.

This is learning, not investing — use only small amounts you treat as tuition.

You just compared real LP pools by Volume/TVL and fee tier — that's exactly the calculation experienced LPs use to decide where to put their money.

Mark as read