How Short Prediction Markets Can Encourage Settlement Manipulation

Summary

The paper examines prediction-market contracts whose settlement depends on an asset price that traders can influence through activity in the underlying market. Its model predicts that such contracts can shift wealth from prediction-market liquidity providers or traders to manipulators, while also degrading price discovery in the underlying asset. The model therefore links contract design to trading incentives across two connected markets.

Evidence comes from Polymarket Bitcoin contracts with five-minute and fifteen-minute horizons. The authors report a surge in spot order flow around settlement for the shorter contracts, followed by substantial price reversals, and describe manipulators capturing profits largely from retail participants. They report that manipulation is largely absent in the fifteen-minute contracts, and argue that a longer horizon can reduce the incentive or opportunity to manipulate settlement. The summary provides no estimation details, profit amounts, or evidence about other assets and venues, so the findings should not be assumed to generalize beyond the studied setting.

Key ideas

• When settlement prices can be moved through underlying trading, prediction contracts may create manipulation incentives.
• The model predicts transfers from liquidity traders to manipulators and weaker price discovery in the underlying market.
• The study reports elevated spot order flow and subsequent price reversals around settlement of short Bitcoin contracts.
• The authors find little manipulation in the longer contracts they examine and identify horizon length as a design tool.
• The supplied description does not establish whether the results extend to other assets or venues.

Tags

# Settlement Manipulation in Prediction Markets


# Settlement Manipulation in Prediction Markets









Prediction markets increasingly list contracts settling on an asset price that holders can move by trading the underlying. We build a model showing that such contracts transfer wealth from prediction-market liquidity traders to manipulators and harm price discovery in the underlying, even as it becomes more liquid. After the launch of Polymarket's five-minute Bitcoin contract, settlement-time spot order flow spikes, causing large price reversals after settlement. Manipulators capture a large amount of profit, mostly from retail. Manipulation is largely absent in the fifteen-minute contracts: lengthening the contract horizon removes it, providing the market-design remedy our model and evidence support.

Shown in full with attribution under the source's licence. Licence: abstract CC0

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.