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 
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
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
- 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...