How to Improve the Internal Market - Steem/SBD - With Better/Fairer Liquidity Rewards and Implied Prices...
Traded Volume on the Steemit internal exchange has been in free fall since Liquidity Rewards were canceled. The founders decision to cancel liquidity rewards made complete sense, however I think this topic is worth revisiting, as there is a big benefit to having a fully functioning internal market on Steemit.
I believe we can achieve a high volume/efficent internal market with some minor changes to the old liquidity rewards system, and the implementation of some new schemes which will keep Steem circulating within the Steemit ecosystem, rather than disappearing to Poloniex and Bittrex.
Why do we need a highly liquid Internal Market?
It is best for me to refer you to posts here and here. There are a number of very good reasons that a strong internal market fits into the @dan and @ned vision for Steemit's future. The key for me is circulation. I believe that, having an easy to access, liquid, trustworthy, low cost (zero) exchange on the Steemit platform will promote circulation, which in turn stabilises the whole Steemit economic system, and moves us towards the stable cryptocurrency that is the ultimate aim of the Steemit project.
The Old Liquidity Reward System
One month ago, traded volume on the Internal Market stood at around $100,000 per day, recently, we rarely hit $1,000. Spreads have widened which have made this market almost unusable in it's current form.
So, Why an Earth were Liquidity Rewards cancelled?
Liquidity Rewards
So if you are thinking about trading then you will need to have a solid understanding of how liquidity rewards work. Every single hour 1200 STEEM ($250+) is awarded to the market maker with the most points. A market maker earns points any time an order of theirs is filled after being on the books for more than 1 minute. Points are calculated based upon the volume of STEEM filled on both sides of the book.
SCORE = BID_VOLUME * ASK_VOLUME
As you can see, you gain the most points when you have equal volume on both sides of the book. After you receive your 1200 STEEM your BID/ASK volume are reset to 0. This means that everyone who trades consistently will eventually get a payout. The more volume you pull the more often you will get to the top of the queue. If you do not trade for a week then your volume will also get reset to 0. So don't get lazy, provide steady consistent liquidity and you will be rewarded.
You only get rewarded for orders filled after being left open for 1 minute. This means canceling / moving your order will reset your time and disqualify you from rewards. It also means leaving orders on the book that never get filled will earn you nothing.
Source: @steemitblog
The main problem that were encountered...
- The Price of Steem Increased 10x from the 4th July, so the liquidity rewards became very valuable. Many users had discontent with the rewards liquidity providers were earning.
- Large Liquidity Traders gamified the system, by working large orders on market, waiting 1 minute, and then brought or sold them to themselves. This is know as Wash Trading, and is highly illegal at almost all conventional financial exchanges (market manipulation).
- Wash Trading - Trading fee's are zero: To put some perspective on this aspect. If I was trading Oil, and I wanted to trade with myself to make it look like a certain price was trading, this would cost my trading fee's on both sides (buy and sell side). But that's not it, I would also get a fine from the exchange (ofter $50,000 to $100,000). There is a large cost to partaking in this activity. Steem Liquidity Rewards were paying users to manipulate the market.
How do Financial Exchanges pay liquidity providers?
Funnily enough, I sit next to bonafide Liquidity Providers at work (I'm an Oil Trader). If an exchange wants to launch a new product, they will often pay Market Makers to quote a Buy side and see side prices, to promote volume from the get go. The deal works as follows;
- The Exchange Pay's the Liquidity Provider $XXXXX per month (fixed fee). In order to receive this payment, the liquidity provider must satisfy the following...
- The Liquidity Provider/Market Maker must be making a price on the Bid and Offer XHours per day, every day
- The Liquidity Provider get reduced trading fee, but still pay's to trade like everyone else
- The Liquidity Provide must provide a spread of less than X%
- The Liquidity Provider is not Required to trade. Their job is to purely make the market, it's up to everyone else of they would like to trade with them
How can we improve the Liquidity Rewards Scheme?
I believe this scheme should be brought back, however it should be tweaked toward the scheme that is offered by financial exchanges. I believe that, rewards should be function of how tight you are making the market spread, over what time period you are doing this, and what volume you are putting into the market and where.
There is also value in having volume depth in a market. I believe that, all orders within X% of last traded price should receive a reward (have it be, a much smaller reward than the orders on market) I don't think that Liquidity Rewards should be a function of the trading volume these users are doing.
I also think that, Rewards should be spread out on a contribution basis, and not rewarded to the number 1 provider, and they should be paid out on a 24hr rolling period. This will allow certain users to provide liquidity for Xperiod per day, knowing they will get a share of Liqidity Rewards Pot at the end of the cycle.
Implied Orders
This brings me on nicely to Implied Orders. Implied orders are (for the purposes of this discussion), orders that are based on prices created on another 'currency pair' or exchange.
What does this mean?
There is an implied price of Steem/SBD created by Poloniex and Bittrex. The market for Steem/SBD doesn't exist on these exchanges, however they both have markets for Steem/BTC and SBD/BTC. From these 2 markets, there is an implied price of Steem/SBD created, which is currently far more liquid and tight (spread) than the internal exchange on Steemit.
There are a number of ways that we could take advantage of this Implied Price on the Internal Exchange
- One way would be for the Steemit Team to set up a algorithm using funds from the @steemit account. By depositing both Steem, Steem Dollars and BTC at Bittrex and Poloniex (or just one of them), it would be possible to imply the price for Steem/SBD from the external exchanges, on the internal market. There would be a small trading costs involved in doing so (with the volume that goes through the external exchanges) so I would further suggest that @steemit sets this algorithm to a small profit (slightly wider spread on the internal market to which they can achieve on the external exchanges), to attempt to cover any Slippage in execution of this strategy.
- We could use the liquidity rewards scheme to incentives the Exchanges to Imply the prices for us. There would certainly be a balancing act between covering lost volume for the exchanges and rewarding them for their service, however I'm sure a equilibrium could be reached. It's not worth forgetting that these exchanges employ liquidity providers in their own right, so they may be more open to it than first appears.
Summary
These are just some idea's I have to improve the internal market, and it would be great to hear anyone's opinions on my thoughts. I personally feel that, Steemit would need to commit to the Liquidity Rewards for the long haul in order to create the internal exchange we all want. This being said, I think the rewards would need tweaking often, in order to remain fair and promote the values we want moving forward...
Honestly I think a good liquidity reward in a decentralized system like this that doesn't get gamed and serves a useful purpose is hard enough to do, and the value low enough, that we should just leave it alone and focus resources on building out the social media portion.
The internal exchange has zero fees and also zero counterparty risk (i.e. Bitfinex risk, most recently) which ought to be enough to attract traders if there is any sort of real market demand at all for the service. If and when that happens, competition and more activity will naturally narrow the spreads there.
The original attempt and the (I believe sincere) attempt to fix it already cost the system over one million dollars in rewards that were paid out and ended up buying very little useful liquidity (at times the spreads were tight, but usually not, and that still ignores the question, even with tight spreads, if anyone actually wants this service very much). That's enough losses on this experiment for me, given what I see as the value of it all (low, but I'm happy to let the market decide).
Great post and suggestions! Indeed, Steemit needs to increase its Internal Market transactions volume to make sense in having one in the end. Obviously, Liquidity Rewards needs to come back to provide strong incentive for transactions there.
One other idea that came to mind while reading your post @hisnameisolllie was to spread the reward across all the accounts that transact on the Internal Market, in equal shares, based on the same formula. A daily payout like this would create engagement for everyone as the reward is spread among all participants and it would be a total 28,800 Steem daily so plenty for everyone.
Also, having the exchanges use their own accounts here (Poloniex, Bittrex) that drive rather a solid volume, I believe setups like the ones used by @abit would be strongly discouraged.
PS: A small typo: 'I believe we can achieved a high volume...'
Great article with lots of insight into how trading markets work. This was my thoughts on how to fix the Liquidity Reward on Steemit, eliminate the reward on Wash Trading, ie. if you execute a wash trade your liquidity score is set to zero. This would greatly reduce the gaming and still encourage a tight margin.
Reduce the Liquidity Reward from 1200 an hour to around 200 an hour. This was approximately the original target reward ($250) before the large price run-up. I do like your idea about rewarding more than just the top liquidity provider. Maybe the top 5 split the reward based on volumn.
I think your proposals make sense @gregory-f The great thing, is, there are a number of ways to approach this, and almost all of them will result in the internal market becoming useable once more
I think also that reducing the liquidity reward is the way to go. Probably something like $10 per hour would be sufficient. It's not too much, but something that a (good) bot could easily earn.
I think you need to reward the risk the liquidity providers are taking by working orders on the market, they don't necessarily want filled.
I personally don't think $10 per hour would come close to cutting it. I also think we need multiple users to fight for the rewards and this will result in the spread closing, and the market become more liquid..
Easiest way is to try it. Let's start with a small sum and raise it slowly until liquidity is on a good level.
Nice post as always. It's nice to hear your background. I used to trade sugars and cotton futures in my pa.
Why do you want the internal market to be high volume? I wish it was fair. A dollar should be worth a dollar and the prices should be aligned with other markets. Sbd trade at a large discount externally. If we could get the exchanges to add the Steem sbd pair it might make it easier to keep all the prices in sync. It seems like the price inside the system is always artificially high.
Less so wanting the volume to be high, I want the internal market to offer at least the same price as moving between 2 market externally, and to be able to move large volume too. I suppose the high volume will be a result of achieving a tight spread and more volume depth.
I'm also not bothered about the $1 peg being absolutely 1SBD=$1. I just think that overall, the Steemit economic system would benefit by having trading activity stay internal, rather than external.
As ever you explain it beautifully; I don't really get trading on a deep level, however what you say seems to make sense.
Did you look at the teeter totter article I posted on your last article on this subject? What I'm driving at is; do you think that liquidity will completely fix the internal market or is this just the easiest, fastest fix?
Cg
I did read that article your refer to. I posted this as a reply;
So, answering your question regarding complete fix/fastest fix? I would say that, the internal market doesn't need fixing, it's just needs more volume to improve. More volume would 'close the loop' on the Steem Economic System allowing users to do every action/transaction efficiently except Exchange Steem or SBD for Bitcoin.
It's silly that users need to Transfer Steem to an External Exchange to Exchange for Steem Dollars, in order to get a better price.
I hope that helps, let me know if you would like me to go into more detail, I could certainly simplify further..
Hi @hisnameisollie, thanks for your reply, I'm sorry I didn't see the other one. OK, well it's good to get an opinion from an experienced trader. So in other words we don't need a delay in SBD or the internal market to close, it's simply a matter of volume, and rewards would fix that?
Cg
No problem @cryptogee
Yep, that's what I think, and that what exchanges all around the world do every time they launch a new product (tradeable asset class).
Very interesting article. I won't pretend I understand everything you talked about, but since you are very knowledgeable in this area I trust that it could have a very positive impact on steemit. Since both @ned and @dan care about users input, I hope this rises to their attention and is considered
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That is the problem. The smart money always games the system to the point of exhaustion
That's why I think, as soon as we get anywhere near that being the case, we should change the scheme to qualm this happening. This would be much better than cancelling incentives all together and having a dud internal market IMO..
I wish I knew more about the markets and how they work. I've been here over a month and did maybe two small exchanges (one to poloniex and one to bittrex)...and the funds are still sitting there because I don't know how to get real cash out. So instead of having tiny bits of cryptocurrency all over the place, it's just sitting in my account. Ignorance is not bliss. LOL
That being said, hopefully the market corrects itself and the value of SBD and STEEM go up so I'm going to keep thinking that watching the small growth in my account is a good thing. I kind of feel like I'm sitting on an egg waiting for it to hatch! LOL