This page will learn how a bonding curve and pari-mutuel betting mechanism works with an example prediction market.
Before we go
Market participants on Forecastory do not usually have to worry about liquidity. This is because the algorithm provides liquidity within the market, but it does not use AMM (Automated Market Makers) like Uniswap. Let's take a look at how people trade on Forecastory.
Forecastory combines two mechanisms; the parimutuel betting mechanism and the bonding curve mechanism.
The pari-mutuel mechanism has a long history as a betting mechanism, and it has been confirmed that it can be used to predict future probabilities as well.
The parimutuel system is simple and works as follows
- Each participant purchases the most likely outcome option(s).
- The investments of each option is pooled into a common pool
- Payouts are paid from the common pool to the winning option based on the results. If you have option tokens of the winning outcome, you can get the funds proportionally to your share of the outcome's token supply. You can learn more on wikipedia
Here is a simplified image of the mechanism
For example, A sample market has the following three outcome options about a future sample event.
In the trading period, each user has traded as below.
User A placed $100 on Outcome 1 and got 100 tokens of Outcome 1.
User B placed $300 on Outcome 1 and got 300 tokens of Outcome 1.
User C placed $100 on Outcome 2 and got 100 tokens of Outcome 2.
User D placed $100 on Outcome 3 and got 100 tokens of Outcome 3.
Total token pool: $600
After the market ends, there is one winning outcome. If the outcome 1 was reported as the correct outcome, the dividend distribution becomes as follows.
User A -> $150 (100 / (100 + 300) * 600)
User B -> $450 (300 / (100 + 300) * 600)
User C -> $0
User D -> $0
For simplicity, the price per token was stable on the example above, but it increases as more people buy it. Details about the price mechanism are described below.
Bonding curve mechanism
As noted, the price of each option is not stable, unlike to the common betting markets based on the pari-mutuel mechanism.
The price of each option increases as more people buy or more probable the option becomes. If you could be determined about the future earlier, you can get dividends more.
This mechanism is called the bonding curve mechanism.
The relationship between price, pooled funds, and the amount of token issued is described as follows.
For example, if the price of outcome A token increases $0.01 at the starting price of $1:
Outcome A token1 = $1.00
Outcome A token2 = $1.01
Outcome A token3 = $1.02
Outcome A token4 = $1.03
Outcome A token5 = $1.04
The same increment is applied to all options within a market.
With this dynamic pricing, you can
1. Sell option tokens later when the price increased.
2. Get dividends more when the redistribution happens.
*For some markets, the sell option is disabled.
As noted, If you bet on the outcomes that didn't become a reality, you lose your stake.
Also, as the dividend redistribution is proportional to your option shares, you might lose a portion of your stake when there were not enough competitive options.
With the above two features, you can build your strategies by hedging risks by
- Hedge risks by selling
- Hedge risks by buying other options
There can be many other strategies you can build around.
All markets created on Forecastory have the following parameters.
- Start price
- Price increment
With these parameters, we can calculate 1) how much option token can be issued when a certain amount of token is pooled, and 2) how much funds should be pooled when a certain amount of option token is issued.
Option token amount for pool
s = start price
a = total pooled amount
r = price increment rate
Pool amount for option token issued
s = start price
p = current price of option token
t = number of option token issued