Author: @BlazingKevin_, Researcher at Movemaker

In Polymarket, each prediction market is essentially a "probability trading exchange for future events", where users can express their judgment about an event by buying a specific option (such as "Trump will win the 2024 US Presidential Election").

Because buying probability events differs from common trading, Polymarket's initial pricing and liquidity mechanism was also different from typical AMM algorithms. Polymarket's pricing mechanism has undergone massive changes from its initial version to now, first adopting an AMM mechanism to provide real-time liquidity and pricing, called the Logarithmic Market Scoring Rule, abbreviated as LMSR. This algorithm is currently also used by some other crypto protocols, such as Ethos.

Understanding the characteristics of LMSR can help comprehend Polymarket's pricing mechanism during most periods, the reasons why other protocols choose LMSR, and why Polymarket upgraded from LMSR to an off-chain order book.

Characteristics and Pros/Cons of LMSR

What is LMSR?

LMSR is a pricing mechanism specifically designed for prediction markets, allowing users to buy "shares" of an option based on their judgment, with the market automatically adjusting prices according to total demand. LMSR's most significant feature is: completing transactions without relying on counterparties, even if you are the first trader, the system can still price and execute the trade. This gives prediction markets "perpetual liquidity" similar to Uniswap.

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• Fundamental Demand for Capital Efficiency: LMSR requires market makers to provide liquidity across the entire price range from 0% to 100%, which leads to a large amount of capital being locked in price points with extremely low trading probabilities, resulting in low capital efficiency. Order books allow market makers and users to precisely concentrate liquidity in the most active price ranges, which highly aligns with professional market-making strategies.
• Optimization of Trading Experience: The algorithmic nature of LMSR inevitably creates slippage for trades of any scale. For markets with increasingly thickening liquidity, this inherent trading friction can hinder the entry of large funds. Mature order book markets can absorb large orders through dense counterparty depth, providing lower slippage and a superior trading execution experience.
• Strategic Need to Attract Professional Liquidity: Order books are the most common and familiar market model for professional traders and market-making institutions. Switching to order books means Polymarket is sending a clear invitation signal to liquidity providers in the crypto world and traditional finance. This is a key step for the platform to move from attracting retail participants to building professional market depth.

Current Pricing and Liquidity Mechanism of Polymarket

Polymarket's upgrade is an inevitable choice after reaching a critical point in user scale and platform maturity. Behind this transformation is a systematic consideration of trading experience, gas costs, and market depth.

Hybrid Mode of On-chain Settlement and Off-chain Order Book

Polymarket's liquidity mechanism adopts a hybrid architecture combining on-chain and off-chain elements, aiming to balance the security of decentralized settlement with the smooth experience of centralized trading.

• Off-chain Order Book: Users' limit orders are submitted and matched on off-chain servers, with instant operations and no gas costs. This makes Polymarket's trading experience similar to centralized exchanges, allowing users to intuitively see market depth from all limit orders. Liquidity thus directly comes from all trading participants, rather than passive liquidity pools.
• On-chain Settlement: When buy and sell orders in the off-chain order book are successfully matched, the final asset transfer is executed through smart contracts on the Polygon chain. This "off-chain matching, on-chain settlement" mode preserves the flexibility of order books while ensuring the finality of trading results and the immutability of asset ownership.

Underlying Logic of Price Anchoring - Share Minting and Arbitrage Cycle

For prediction markets, the core mechanism is how to ensure that the probabilities of "Yes" and "No" results always sum to 100% (i.e., "$1"). The order book mode itself does not code-enforce order prices, but instead uses a sophisticated underlying asset design and arbitrage mechanism to leverage the market's own corrective power to ensure prices always converge to "$1".

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In summary, the combination of Polymarket and DEX is not a simple functional stacking, but a deep integration at the infrastructure level. Polymarket is evolving into a "risk pricing layer" and "information oracle" for the entire crypto industry. As the traffic brought by X gradually penetrates, its integration with basic protocols like DEX will no longer be optional, but a key variable determining whether the future DeFi ecosystem can become more efficient, mature, and resilient.

About Movemaker

Movemaker is the first official community organization authorized by the Aptos Foundation, jointly initiated by Ankaa and BlockBooster, focusing on promoting the construction and development of the Aptos ecosystem in the Chinese-speaking region. As the official representative of Aptos in the Chinese-speaking region, Movemaker is committed to creating a diverse, open, and prosperous Aptos ecosystem by connecting developers, users, capital, and numerous ecosystem partners.

Disclaimer:

This article/blog is for reference only, representing the author's personal views and not the position of Movemaker. This article does not intend to provide: (i) investment advice or recommendations; (ii) an offer or solicitation to buy, sell, or hold digital assets; or (iii) financial, accounting, legal, or tax advice. Holding digital assets, including stablecoins and Non-Fungible Tokens, carries extremely high risks with significant price volatility and potential to become worthless. You should carefully consider whether trading or holding digital assets is suitable for your financial situation. For specific questions, please consult your legal, tax, or investment advisor. The information provided in this article (including market data and statistics, if any) is for general reference only. Reasonable care has been taken in writing these data and charts, but no responsibility is accepted for any factual errors or omissions.