Typical stock exchange is a lot of like eBay bidding auction. A full-depth of quote book is maintained for the best and near-best bid and offers. When a buyer's highest bid price matches with a seller's lowest offer price matches, an transaction is made. For those bids and offers that are below/above the current market price, they are kept on the books.
Now HFT algorithms, daytraders and market-makers all monitor this full-depth book for patterns whenever a large order is coming in. Suppose I'm a Fidelity Investment trying to acquire 5 million shares of MSFT for my $20 billion mutual fund, if I just put that huge order out there on the order book. Everyone else will jump in and buy MSFT; front-running me because stock market is like everything else, supply-and-demand; when there's a huge demand and you buy the supply ahead of time, you can charge more and make profit.
So to disguise my huge order, mutual funds prefer dark pools where the full-depth of books are not maintained. Instead, it's like shooting fish in the dark. A big mutual fund wants to buy 5 million shares of MSFT at 25, another big fund wants to sell 5 million shares at MSFT at 25. You submit your order to that market totally blind because there's no quote book and just have to see if your order gets filled. But the positive side is that no one could see where the market demand and supply is, so the mutual funds gets their orders filled and not front-runned. Dark pools also typically limit their participants to large institutional investors to limit the information because what HFT firms used to do is to "ping" the dark pools, send out random orders to buy 1 share of MSFT at a certain price to see if there's a "whale" order out there and then proceed to front-run. So lots of them got banned.
Now, the problem with dark pools is that there are sometimes not many people who trade on it because it's "dark," kind of like egg-and-chicken problem, no one could see the full-depth of book and so don't put their orders out there. That's what's called lack of "liquidity". Exchanges want to have people trade, because the higher volume, the more people will come and trade on that venue and the more money they make. So this "light pool" tries to fix this problem by having "displayed" quote book but the market participants are still limited and regulated still to make mutual fund participants comfortable about not being front-runned.
Well, as the saying goes, "it's never illegal unless you get caught"; so suppose if you are a huge fund or a bank with a HFT prop desk. You could register your mutual fund section with this "light pool" for its displayed liquidity. Now, you might even do some real trades on the exchange to make everything legit; but feed the market data section for your HFT prop desk which is registered with a totally different LLC designation, and have that fund execute orders on other exchanges based on information from this "light pool" (e.g., whale buy order on IBM on "light pool," front-run IBM on BATS).
Now for liquidity rebates on these exchanges, exchanges are now locked in a bitter battle to see who can attract the most volume and trades (because it's a snowball effect, more volume, more interested traders who come on to trade, more money). So they offer "liquidity rebates" for traders who put orders out there on the full quote-book because the more entries on a exchange's order book means that there are greater potential for greater volume on a exchange. A more concrete example is, let's say I'm a liquidity rebate trader on Citigroup (NYSE: C); C is last traded at $4.30, with national's best bid at 4.29 and national's best offer at 4.30 (NBBO). So I could submit out a sell order for C at $4.30 on the exchange's quotebook (I don't have to physically own C, I could short sell the stock). Now although NBB was at 4.29, someone might come alone and they are really impatient and submit a market order to buy C at $4.30 and they hit my order; now they are "taking" liquidity that I put out there on the market. So they are paying the exchange for the liquidity for doing so, typically, $0.02-$0.05/100 shares and to encourage more liquidity providers like me, the exchange passes some of that profit to me, $0.01-$0.03/100 shares.
Now a stock like C is heavily traded, there are literally thousands of orders on C's quotebook just between $4.30 and $4.29; suppose that a bad/good news come out on Citigroup, many of the traders who have their offers to buy or sell C at these cents increments might not all cancel their orders to adjust the valuation of C to the new news. This is called "low slippage," that in a high volatile event, you could trade out of your positions very easily with no "slippage" as trading in a small cap stock where in a volatile event, no one's willing to trade with you.
This is perfect for a liquidity rebate trader who literally goes around all day, offer to sell C at 4.30 and then buying back their short C shares at 4.30. They break even on the trade and get to collect $0.02-$0.05/100 shares liquidity rebates. So you do this over and over again on the market, generating higher volume on the exchanges and get to collect more rebates and everyone's happy at the expense of the liquidity takers. Now, with this exchange, the liquidity rebate is at $0.14/100 shares because they want to be attractive to the liquidity rebate crowd and generate lots of volume; and because the rebate is high, you could afford even higher slippage on C.
