Self-regulatory bodies like NASDAQ compensate market makers who provide liquidity for long-tail markets, under certain conditions. Meteora (or other AMM polatforms) should be able to use this framework in the US to incentivize liquidity provision in markets that wouldn't otherwise have enough volume by compensating market makers.
With a framework that allows market makers to self-separate into designated and undesignated entities, similar to US-based Financial Industry Regulatory Authority (FINRA) designated liquidity providers', Meteora could then establish compensation schedules for long-tail markets. This would add credibility and transparency to provided capital, and would enable MET to be used as a staking "utility" token that unlocks fee distribution to desgnated LP's.
Existing US financial market regulations such as the exemption under FINRA Rule 5250(a)(3), permit Self-Regulatory Organizations (SROs) like NASDAQ to compensate registered market makers if they comply with certain requirements, promoting market efficiency and liquidity.
The lack of clear regulatory guidance for DEXs and their liquidity providers creates uncertainty and hinders growth in the DeFi space. This uncertainty could damage Meteora's future, as the pending large capital raises by Pump.fun and others will make it challenging for Meteora to compete.
How can Meteora launch MET such that it has a pathway to "utility" status, with sustainable long-term value other than simplistically granting cash flows to staked token holders? Buybacks have been employed elsewhere and have been proposed already. Are there other creative options?
Create a novel market for compensating market makers for long-tail liquidity provision, modeled on the Designated Liquidity Provider (DLP) programs in traditional finance. Of course in crypto we don't have a regulatory body with whom to register (so far), but Meteora can break new ground by offering compensation to market makers willing to voluntarily register. This version 0 has not yet been edited by any AI system or gotten community feedback. Please help.
Possible registration process:
- Register accounts (onchain).
- Attest offchain to specific requirements, modeled on DLP programs, potentially including:
- Legal Jurisdiction
- Compliance with local Anti-Money Laundering (AML) and Know Your Customer (KYC) regulations
- Indemnification of Meteora
- Capital Requirements (as needed)
- Stake MET in proportion to expected fees and as collateral for slashing
- Fee "schedule" publication by Meteora
Regardless of the jurisdiction or the prevailing local securities and money laws, in no jurisdiction is it legal to make false representations or commit fraud. This framework is about disclosure and creating a market maker disclosure regime similar in approach to the Blockworks token transparency initiative (https://blockworks.co/token-transparency).
This will accomplish two things:
- Create sustained demand for MET with the stake/burn registration system, giving the token far more goodwill and intangible value than competing AMMs.
- Make Meteora the leader in moving to more fair and transparent markets. This will not only demostrate Meteora's unparalleled committment to long-tail crypto markets but, more importantly, open the door for other companies to share the load as we move gradually toward global self-regulatory systems.
FINRA Rule 5250(a)(3) allows payments to market makers "expressly provided for under the rules of a national securities exchange that are effective after being filed with, or filed with and approved by, the SEC". This exception facilitated market maker incentive programs for exchange-traded products (ETPs), which improved market quality, depth, and liquidity.
Applying similar logic to DEXs, a registered DEX could establish registration guidelines and rules for compensating liquidity providers. This would allow DEXs to incentivize liquidity provision, leading to a more efficient and liquid market for digital assets without classifying the activity as a security under the Howey Test.
Benefits:
- Increased Liquidity
- Reduced Regulatory Uncertainty
- Innovation and Growth
- Investor Protection
The Crypto Industry will eventually have either its own version of FINRA or partner with the existing association.
Financial market regulations are not static and are regularly refined to improve market depth and efficiency. For example, NASDAQ recently modified their DLP rules to include additional incentives, highlighting the dynamic nature of these frameworks. This adaptability should also apply to DEXs, as we take more reponsibility for the evolving regulatory needs of the crypto industry.
By using FINRA Rule 5250(a)(3) as a template and incorporating lessons from the evolution of financial market regulations, a framework can be established that allows DEXs to compensate liquidity providers, promoting a more efficient and liquid market for long-tail assets while mitigating regulatory risks.
- FINRA Rule 5250(a)(3)
- Regulatory Notice 20-03 | FINRA.org
- Regulatory Notice 17-41 | FINRA.org
- FINRA Rule 5250 - SIFMA
- NASDAQ DLP Rules (Example: NASDAQ MQP - see FINRA Regulatory Notice 20-03)
- Also NASDAQ: Rules change regularly, for SRO's benefit (https://www.nasdaq.com/articles/new-market-maker-incentives-help-nasdaq-stoke-etf-liquidity-2021-09-16#:~:text=Under%20the%20revised,their%20transaction%20incentives)
The author also considered the public OTC market structure, with its payment-for-order-flow (PFOF) alternative trading systems rules, for this proposal. However, the PFOF compensation system has been changing, and using this legal precedence awkwardly requires thinking of exchange liquidity providers as "brokers" and the platform as the market maker.