Decentralized Prediction Markets and Sports Books

TL;DR

This paper proposes a decentralized prediction market framework using automated market makers, analyzing liquidity management, pricing properties, and fee structures to ensure market efficiency and participant incentives.

Contribution

It introduces a novel liquidity-based AMM structure for prediction markets with axiomatic utility functions, ensuring desirable financial properties and fee mechanisms.

Findings

Liquidity pooling affects market stability and pricing

Proposed fee structures compensate liquidity providers effectively

The framework satisfies key financial axioms for prediction markets

Abstract

Prediction markets allow traders to bet on potential future outcomes. These markets exist for weather, political, sports, and economic forecasting. Within this work we consider a decentralized framework for prediction markets using automated market makers (AMMs). Specifically, we construct a liquidity-based AMM structure for prediction markets that, under reasonable axioms on the underlying utility function, satisfy meaningful financial properties on the cost of betting and the resulting pricing oracle. Importantly, we study how liquidity can be pooled or withdrawn from the AMM and the resulting implications to the market behavior. In considering this decentralized framework, we additionally propose financially meaningful fees that can be collected for trading to compensate the liquidity providers for their vital market function.