How Does Polymarket Work?

At the intersection of blockchain and financial innovation, Polymarket, as the world’s leading decentralized prediction market platform, has become Web3 A benchmark in the field. This article will analyze its operating principles and core competitiveness from the dimensions of technical architecture, trading logic, liquidity management, and business model.

Decentralized framework and user engagement process

Polymarket is built on the Ethereum blockchain and implements Polygon The Layer-2 scaling solution optimizes transaction efficiency to achieve low-cost processing capacity of thousands of transactions per second. Users can participate without traditional financial intermediaries or completing KYC verification, only by connecting non-custodial wallets such as MetaMask. The platform’s core asset is the stablecoin USDC pegged to the US dollar, ensuring the stability of transaction valuation.

User participation steps:

1. Registration and Wallet Creation: Generate a dedicated on-chain wallet through email or an existing Ethereum wallet (such as MetaMask), with the private key fully controlled by the user.
2. Deposit funds: Transfer USDC to your wallet as collateral for trading.
3. Market selection: The platform provides a prediction market with diverse themes such as political elections, sports events, cryptocurrency prices, etc., and users can filter events of interest.
4. Trade Execution: Buy ‘Outcome Shares’ at a price ranging from 0.01 to 1.00 US dollars, with prices dynamically reflecting the market consensus on the probability of the event occurring.
5. Settlement and Withdrawal: After the event result is verified by the decentralized oracle, correct predictors can redeem USDC at $1 per share, while incorrect predictors will be reset to zero.

Smart Contracts and Oracles: The Cornerstones of Automation and Transparency

Polymarket operates highly dependently on smart contracts, covering the entire process of market creation, trade execution, and outcome settlement. For example, when users purchase shares of “yes” or “no”, smart contracts will automatically generate conditional tokens based on the ERC-1155 standard, and through Gnosis The Conditional Token Framework (CTF) implements tokenization.

Key Mechanism:

• Oracle Integration: The platform adopts UMA’s Optimistic Oracle to verify event outcomes. This mechanism ensures data authenticity through a two-stage dispute resolution process (challenge period and arbitration voting), preventing centralization control.
• Dynamic Liquidity Management: Initially relying on the Automated Market Maker (AMM) model, later introducing a Combined Order Book System (CLOB/BLOB), combining limit orders and market orders to enhance trading depth and execution efficiency.

Liquidity incentive mechanism and business model

Polymarket’s liquidity providers (LPs) earn profits by injecting funds into the market, and its model is divided into two categories:

1. Transaction fee split: Approximately 2% of the fee is charged per transaction, with the majority being rewarded to LPs to incentivize them to provide limit orders close to the market price.
2. Liquidity Incentive Program: Based on the proximity of limit orders to market prices, additional USDC rewards are distributed to LPs daily, similar to dYdX Liquidity incentive strategy.

The platform’s main source of revenue comes from the growth of the trading volume, rather than directly charging fees. This model reduces user costs, while relying on high trading volumes to maintain ecosystem vitality.

Competitive advantages and potential challenges

Core strengths:

• Extensive market coverage: covering diverse themes such as politics, sports, entertainment, etc., and the prediction results are often quoted by mainstream media, forming cross-circle influence.
• Low threshold and high transparency: Non-custodial wallets and on-chain records ensure fund security, allowing users to track transaction status in real time.

Risks and Challenges:

• Regulatory Uncertainty: Fined $1.4 million by the Commodity Futures Trading Commission (CFTC) in the United States for compliance issues, it needs to continuously adjust its service scope to respond to policy changes.
• Liquidity fluctuations: Uncommon events may lead to trading slippage due to insufficient LP participation, affecting user experience.

Future Outlook: AI and Market Expansion

With the introduction of AI agents, the future prediction market may realize automated strategic trading and real-time data analysis, further improving market efficiency. At the same time, Polymarket is exploring complex products such as ‘Parlay’ to allow users to combine multiple events for leveraged predictions, expanding the application scenarios of financial derivatives.

Through blockchain technology and innovative mechanisms, Polymarket is redefining the way information aggregation and value exchange are done. Its decentralized architecture, dynamic liquidity model, and transparent settlement process not only provide individual users with low-threshold speculative tools but also serve as a reliable reference for global event probability prediction. With technological iterations and ecosystem expansion, Polymarket is expected to occupy a more central position in the integration of Web3 and fintech.