FReT Improvement Proposal: Protocol-Embedded Market Making via Miner Execution
Summary
FReT defines a system where circulating supply is dynamically adjusted through issuance and burn functions based on market conditions. This proposal extends that framework by integrating market making as a protocol-level function, executed by miners under strict rules and incentive constraints.
Market making is not treated as an external activity but as a core component of monetary policy, operating alongside supply adjustment. The objective is to ensure that price discovery, liquidity, and supply adaptation form a coherent and self-reinforcing system.
System Principle
- FReT controls supply
- Market making controls the price surface (liquidity, spreads, volatility)
The system forms a closed loop:
Liquidity conditions → price signals → FReT adjusts supply → new liquidity conditions
Market making acts as a signal amplifier.
If externalized, it introduces distortion and rent extraction.
If embedded, it becomes a stabilizing mechanism.
Design: Protocol Market Making
Market making is implemented as a UTMM primitive, executed by miners under deterministic rules.
- No discretionary trading
- No strategy selection
- No off-chain coordination
Miners act as protocol-aligned liquidity operators, not profit-maximizing traders.
Structural Components
1. Liquidity Bands
The protocol defines:
- Target price bands
- Minimum depth requirements
- Maximum spread constraints
Example:
- Inner band: ±2%
- Outer band: ±10%
The system enforces:
- Continuous liquidity within bands
- Minimum capital deployment
This is policy execution, not strategy.
2. Coupling with FReT
Supply and liquidity are jointly controlled:
-
If price > target:
- Increase issuance
- Increase sell-side liquidity
-
If price < target:
- Increase burn
- Increase buy-side liquidity
Supply adjustment and liquidity shaping operate in a single control loop.
3. Inventory Constraints
The system enforces:
- Inventory caps
- Automatic rebalancing
- Neutral positioning
Miners are not permitted to accumulate directional exposure.
Objective: neutral liquidity provision, not speculation.
Incentive Model
Participation must be economically dominant.
1. Conditional Block Rewards
-
Full rewards require:
- block production
- compliant liquidity provisioning
-
Non-compliance:
- reduced or zero rewards
2. Bounded Spread Participation
- Miners earn a share of spreads
- Spreads are protocol-constrained
Ensures:
- revenue scales with activity
- no rent extraction via widening
3. Stability Incentives
Additional rewards for:
- maintaining price within band
- reducing volatility
Explicitly rewards stability provision.
4. Inventory Risk Compensation
Where exposure exists, compensation mechanisms include:
- funding flows
- inventory rebates
- dynamic fee adjustments
Without this, rational participation collapses.
Risks and Constraints
1. Miner Coordination Risk
Potential behaviors:
- spread widening
- liquidity withdrawal
- band manipulation
Mitigation:
- verifiable on-chain liquidity commitments
- enforced policy constraints
2. Adverse Selection
Miners act as passive counterparties.
Without compensation:
- losses accumulate
- liquidity disappears
3. Policy Conflict
If liquidity policy and supply policy diverge:
- stabilization and contraction can conflict
Resolution:
- unify both within a single UTMM control function
Miner Execution Model (Deterministic)
Design Objective
- Minimize operational complexity
- Eliminate timing attack surfaces
- Maximize participation
- Reduce infrastructure requirements
Miner Responsibilities
Miners do three things only:
- Deposit capital (infrequent)
- Produce blocks
- Call a single function per block
Per-Block Execution
executeMonetaryPolicy()
This function:
-
adjusts supply (issuance / burn)
-
updates liquidity positioning
-
distributes rewards and penalties
No additional interaction is required.
Capital Provisioning
Miners deposit into a protocol-controlled contract:
LiquidityVault
Properties:
-
one-time or infrequent deposits
-
no per-block funding
-
withdrawal subject to delay
The vault:
-
aggregates miner capital
-
exposes it to protocol-controlled liquidity logic
Liquidity Execution
Liquidity is managed entirely by the protocol.
The system:
-
reads market state (price deviation, volatility, flow)
-
computes required liquidity distribution
-
updates internal pricing curves
Recommended implementation:
- banded AMM or virtual AMM (vAMM)
Properties:
-
no order placement
-
no cancellation
-
no latency dependence
-
fully deterministic
Inventory Management
Miners do not manage inventory.
The protocol:
-
tracks exposure per share
-
enforces limits
-
rebalances automatically via:
-
mint/burn (FReT)
-
internal swaps
-
Inventory risk is handled at the system level.
Rewards and Penalties
Rewards:
-
block rewards
-
share of fees
-
stability incentives
Penalties:
- insufficient liquidity → reduced rewards or exclusion
Funding Flow
-
Initial: miner deposits capital
-
Ongoing: rewards accrue automatically
-
No continuous topping-up required
Withdrawals:
- delayed to prevent opportunistic exit
System Synthesis
The system forms a unified structure:
-
FReT: adjusts supply
-
Market Making: adjusts liquidity and price surface
-
Miners (or ARCOs): execute both deterministically
Miners function as monetary operators, not just validators.
Required Next Step
Define a Liquidity UTMM Module with:
Inputs:
-
price deviation
-
volatility
-
order flow
Outputs:
-
liquidity distribution
-
spread parameters
-
depth targets
Constraints:
-
inventory limits
-
capital allocation rules
Incentives:
- reward and penalty functions
Conclusion
Market making must be internalized as part of monetary policy.
If externalized:
-
it introduces extraction
-
distorts signals
If embedded:
-
liquidity aligns with protocol objectives
-
price signals improve
-
supply adjustment becomes effective
This removes reliance on external market makers and integrates liquidity provision directly into the economic logic of the system.