Feature them, give them exposure. Get them sales. Just take your modest cut. 400k users is an awesome sandbox, don't waste it!
1) The site is setup for individual musicians, not bands or acts. I'm really targeting the high school kid who sits on his bed and plays lightening-fast guitar solos. He doesn't have anything to sell.
2) If I promised that kid he'd make significant (to him) $$ selling his music, I'd probably be lying.
3) Most musicians aren't going to make money selling their music. But they get a high out of having lots of people listen to it. So I'd rather just let people give it away for free and optimize for generating lots of plays, which would make them happy. Vs helping them sell it only to be disappointed.
a) HQ microphones are not a very usual thing to have and they are not cheap and
b) because lag will probably kill the experience, even with a very good connection, a delay of, say, 150ms will be noticeable when playing music relying on reacting to each other.
The second issue is real and since I know nothing about how to solve it perhaps the idea is dead in the water for now. But anthonyb's suggestion of recording all the tracks separately and allowing the musicians to mix them in post might be one way of going around this.
The latency might be an issue live, but there's no reason that the musicians couldn't (eg.) Lay down drum tracks, bass tracks, etc. and mix them up afterwards.
Sorry for the sporatic, it was a brain dump...