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Glossary/Market Mechanics

Market Mechanics Glossary

Order books, automated market makers, liquidity, and the machinery of a market

12 terms

A1 term

Automated Market Maker

An automated market maker (AMM) is a smart-contract-based system that prices and settles trades algorithmically using a mathematical formula rather than matching buyers and sellers through a traditional order book. In prediction markets, AMMs ensure continuous liquidity for every outcome.

L4 terms

A limit order is an instruction to buy or sell a prediction market contract at a specific price or better, resting on the order book until a counterparty matches it or the order is cancelled. Unlike a market order, it guarantees a price but not an immediate fill.

Liquidity in a prediction market measures how easily a trader can buy or sell contracts at prices close to the current market quote, in meaningful size, without significantly moving the price. High liquidity means tight spreads, deep order books, and minimal slippage.

Liquidity Provider

A liquidity provider (LP) is a trader or automated system that continuously quotes both buy and sell prices for prediction market contracts, adding resting orders to the order book or depositing capital into an AMM pool. In return, LPs earn a share of trading fees and may receive maker rebates.

Logarithmic Market Scoring Rule

The Logarithmic Market Scoring Rule (LMSR) is a cost-function-based automated market maker designed for prediction markets by economist Robin Hanson. It guarantees continuous liquidity, keeps prices bounded between 0 and 1, and caps the market operator's worst-case loss at a known value.

M3 terms

Maker and Taker

The maker-taker model is a fee structure used by prediction market exchanges that charges different rates based on whether an order adds liquidity to the order book (maker) or removes it (taker). Makers place resting limit orders; takers fill those orders with market or aggressive limit orders.

A market order is an instruction to buy or sell a prediction market contract immediately at the best available price, consuming existing resting orders on the order book. It prioritizes speed of execution over price certainty.

Matching Engine

A matching engine is the core software component of an exchange that receives incoming orders, compares them against resting orders in the order book, and executes trades when a buyer and seller agree on price. It determines who trades with whom, at what price, and in what sequence.

O1 term

An order fill is the execution of a buy or sell order in a prediction market, confirming that the specified quantity of contracts has been matched with a counterparty at an agreed price. Orders can be fully filled, partially filled, or left unfilled depending on available liquidity.

P1 term

A position is the quantity of a prediction market contract a trader currently holds, either long (holding YES shares expecting the event to occur) or short (holding NO shares or having sold YES shares expecting the event not to occur). A position represents real financial exposure until it is closed or the market resolves.

T2 terms

Tick size is the minimum price increment by which a prediction market contract can move or be quoted. On most binary prediction markets, the tick size is one cent ($0.01), meaning contracts are priced in whole cents between $0.01 and $0.99.

Trading fees are the costs charged by a prediction market exchange for executing a trade, typically expressed as a percentage of the contract value or a per-contract cent amount. They represent the primary revenue mechanism for regulated platforms and directly reduce a trader's net returns.