Polkamarkets 101 Series: How are market prices determined?
For the seventh article of the Polkamarkets 101 Series, we cover the topic of how market prices are determined. Polkamarkets 101 is a series of videos and extended Help Center articles that make it easier for users to get started with Polkamarkets.
A prediction market creates an exchange where traders can take a position in the possible outcomes of a future event. Outcome positions can be bought and sold at any moment at the market price. The price of the outcomes depends on supply and demand. But how exactly are they determined?
How are market prices determined?
Every market in the Polkamarkets Protocol has two possible outcomes: outcome 1, or outcome 2 (for example, Yes or No).
Each market has three pools of shares: the liquidity pool, the outcome 1 pool, and the outcome B pool. The three pools are always kept in balance, using Liquidity as the constant. Prices are determined according to the amount of shares in each outcome pool, which vary at each trade.
The number of shares in each pool is the result of the following function: shares of outcome 1 * shares of outcome 2 = shares in the liquidity pool.
To always maintain the shares in the liquidity pool, the number of shares in the pool of each outcome is adjusted during the execution of a trade, therefore changing the price of the outcomes. When a trader buys shares in outcome 1, the number of shares in outcome 2 increases. Therefore the price of outcome 1 increases, while the price of outcome 2 decreases.
When a market is created, the outcome prices are even: 0.5 for outcome 1, and 0.5 for outcome 2. As soon as the first trade happens, the number of shares in the pool will change, and the price will be adjusted accordingly.
The exact impact on the price will depend on the number of shares that the trader is buying, which itself depends on the amount they’re spending on the purchase. The Polkamarkets app will always inform traders of the details at the time of purchase or sale.
While a market is open, the price of outcomes is always between 0 and 1 in whatever the currency of the market is. After the market is resolved, the winning outcome will have a price value of 1, while other outcomes will be 0.
How do liquidity and market resolution work?
Now that you better understand how the price of outcomes is determined, it’s important to also understand the crucial role that liquidity pools play in the Polkamarkets Protocol, as well as what happens upon market resolution.
To dig further, we recommend the following resources:
We highly recommend that you read our article on Strategies and risks for Liquidity Providers before you decide to create a market or provide liquidity. You’re also welcome to join the Polkamarkets community in Discord to ask questions and debate strategies.
You can learn more in the help center, where you’ll find information regarding the following topics:
- Basic information about the Polkamarkets Protocol
- How to create a verifiable market
- POLK Token & Tokenomics
- Other Frequently Asked Questions
Polkamarkets is an Autonomous Prediction Market Protocol built for multi-chain information exchange and trading where users take positions on outcomes of real-world events–in decentralized and interoperable EVMs.