Automated Market Makers (AMMs) are algorithms that provide continuous prices without requiring a traditional order book full of traders. In prediction markets, AMMs are often used to keep niche or new markets tradable from day one.
What an AMM Does
An AMM:
- Quotes prices based on a formula.
- Accepts trades against its pool.
- Adjusts prices after each trade to reflect updated implied probabilities.
Instead of matching buyers and sellers directly, traders interact with a pricing rule.
Why AMMs Are Popular in Prediction Markets
AMMs help prediction markets because:
- Many markets are niche and would have empty order books.
- Users want instant execution without waiting for a counterparty.
- Platforms want to list many markets without fragmenting liquidity completely.
The Cost of Liquidity
AMM liquidity is not free:
- Large orders cause slippage because the AMM must move price to stay solvent.
- Someone bears inventory risk: a liquidity provider, the platform, or subsidy mechanisms.
In practice, AMMs trade off execution quality for always-on tradability.
Common AMM Patterns
You will see different approaches:
- Constant product style pools (DeFi-like) for outcome tokens.
- LMSR-style market makers that guarantee liquidity but require a subsidy budget.
- Hybrid models that combine an order book with an AMM backstop.
Key Takeaways
- AMMs make markets tradable even when humans are not quoting.
- Slippage is the price you pay for instant liquidity.
- Hybrid designs often aim to get the best of both worlds.