How do prediction markets like Polymarket work?

A prediction market lets people buy and sell shares that pay out based on whether a future event happens. On Polymarket, each outcome share pays $1 in USDC if it turns out correct and $0 if not, so its trading price, say $0.63, reads as the crowd's rough estimate of a 63% chance. Trades are matched off-chain but settled on the Polygon blockchain, and an oracle decides the outcome when the event ends.

The basic idea: prices as probabilities

Every market asks a question with a clear answer, such as "Will candidate X win the election?" For a simple yes-or-no market there are two tokens: YES and NO.

• If the event happens, each YES share redeems for $1 and each NO share for $0.
• If it doesn't, the reverse is true.

Because exactly one side wins, the prices of YES and NO should add up to about $1. If YES trades at $0.63, NO should trade near $0.37. Anyone who thinks the true chance is higher than 63% has a reason to buy YES. Anyone who thinks it is lower has a reason to sell YES or buy NO. That buying and selling pushes the price toward the collective view of the traders.

You buy	Price paid	Event happens	Event doesn't happen
100 YES shares	$63	Receive $100	Receive $0
100 NO shares	$37	Receive $0	Receive $100

The price is not a guarantee or a forecast from an expert. It is simply what the last buyer and seller agreed on. Thin markets with few traders can be moved easily and may not reflect good information.

Where the shares come from

Polymarket's outcome shares are built on the Conditional Token Framework (CTF), an open-source set of smart contracts originally developed by Gnosis. The key trick is that shares are created in complete sets:

1. A user deposits 1 USDC (a dollar-pegged stablecoin) into the contract.
2. The contract mints one YES token and one NO token. This is called a split.
3. Either token can then be sold separately on the market.
4. At any time, one YES plus one NO can be merged back into 1 USDC.
5. After the market resolves, winning tokens are redeemed for 1 USDC each.

This design means every share in circulation is fully backed by collateral locked in the contract. Polymarket does not need to take the other side of anyone's bet or hold a pool of house money. The payout to winners is simply the USDC that both sides put in.

The tokens themselves follow the ERC-1155 standard, which lets one contract manage many different token types. Each market's outcomes get their own token IDs.

Markets with more than two outcomes, like "Who will win the championship?", are handled as a group of linked yes-or-no markets, one per candidate. The contracts let traders convert between positions across the group so the prices stay consistent.

How trading works: a hybrid order book

Polymarket uses a central limit order book (CLOB), the same model stock exchanges use. Traders post bids and asks at chosen prices, and the book matches them. Earlier versions of the platform used an automated market maker instead, but the order book gives tighter prices when there are active traders.

The order book is a hybrid:

• Off-chain: Orders are signed messages created in the user's wallet. An operator collects them and matches buyers with sellers. This keeps posting and cancelling orders fast and free.
• On-chain: When orders match, the trade is settled by an exchange smart contract on Polygon. The contract checks the signatures and moves the tokens and USDC directly between the two users' wallets.

The operator can match orders but cannot move funds without a valid signature from the user. That makes the system non-custodial: users keep control of their assets, and the trade only executes on the terms they signed.

A single trade can be settled in a few ways. If a YES buyer and a YES seller meet, tokens simply change hands. If a YES buyer at $0.63 meets a NO buyer at $0.37, the contract can mint a fresh YES/NO pair from their combined $1 and give each side their token.

Why Polygon

Polygon is a blockchain that is compatible with Ethereum's smart contracts but has much lower transaction fees. That matters for a trading app. Settling many small trades, splitting and merging tokens, and redeeming winnings would be expensive on Ethereum's main network. On Polygon, those actions usually cost a fraction of a cent.

Users typically fund their account with USDC on Polygon. Many users sign in with an email or a browser wallet, and the app creates a smart-contract wallet for them behind the scenes, so they don't have to manage gas tokens directly.

How outcomes are decided

The hardest part of a prediction market is not trading. It is deciding, fairly and without a single trusted party, what actually happened. Polymarket uses UMA's Optimistic Oracle for most markets.

"Optimistic" means an answer is assumed to be correct unless someone challenges it:

1. After the event, a proposer submits the outcome and posts a bond (a deposit that can be lost).
2. A challenge window opens, typically lasting a couple of hours.
3. If nobody disputes, the proposed answer is accepted and the market resolves.
4. If someone disputes, they post their own bond. The question can be re-proposed, and a second dispute escalates it to a vote by holders of UMA's token.
5. Whoever turns out to be wrong loses their bond to the side that was right.

Each market also has written resolution rules that spell out what counts as "yes" and which sources settle it. Reading these rules matters. Disputes often arise from edge cases, such as an event that technically happened but not in the way most traders assumed.

What moves prices and who trades

Prices move when traders act on new information: a poll, a court ruling, an injury report, a statement from an official. Because the market is open around the clock, prices can react within minutes.

Three types of participant are common:

• Informed traders who believe they know something the price doesn't yet reflect.
• Market makers who post buy and sell orders on both sides and earn the spread between them. They provide the liquidity that makes trading possible.
• Arbitrageurs who profit when related markets, or the same event on different platforms, are priced inconsistently. Their trades pull prices back into line.

Researchers have long studied whether markets like these forecast well. The general finding is that liquid markets are often competitive with polls and expert forecasts, but they can be wrong, and they can be influenced by large traders or by traders' own preferences.

Risks and limits

• Oracle and rules risk. A market can resolve in a way you think is wrong, especially if its rules are ambiguous.
• Liquidity risk. In small markets, you may not be able to sell before resolution without accepting a poor price.
• Smart contract risk. Funds sit in contracts, and bugs in contracts are always possible.
• Stablecoin risk. Payouts are in USDC, which depends on its issuer keeping the peg.
• Legal risk. Prediction markets are treated differently in different countries. In the United States, event contracts fall under the Commodity Futures Trading Commission (CFTC). Polymarket settled with the CFTC in 2022 and blocked US users from its main platform, and in 2025 it acquired a CFTC-licensed exchange to offer a regulated US product. Rules keep changing, so check what applies where you live.

Key takeaways

1. Each outcome share pays $1 if correct and $0 if not, so its price reads as an implied probability.
2. Shares are minted in fully collateralized YES/NO pairs using Gnosis's Conditional Token Framework.
3. Orders are matched off-chain but settled on-chain on Polygon, so users keep custody of their funds.
4. UMA's Optimistic Oracle resolves outcomes, with bonds and token-holder votes for disputes.
5. Prices reflect traders' beliefs, not certainty, and thin markets can be misleading.
6. Legal status depends on where you live and continues to change.