How does liquidity work at Polymarket?

The current market structure uses Automated Market Makers (AMMs). Rather than have a centralized market maker that provides liquidity like the NYSE, the markets allow any user to add liquidity to the pool of assets.

Each liquidity pool (LP) share that is owned will mint a set of 1 token for each outcome. If there is a question with outcomes YES and NO, each LP share mints 1 YES and 1 NO.

Why is liquidity necessary for the markets?

Lower liquidity causes a larger, negative price impact when buying or selling outcome tokens. Imagine that there was an Olympic swimming pool and a children's pool. If someone took out 3 liters of water, the volume of the smaller pool would decrease by a greater percentage than the larger pool.

What is the incentive for me to add liquidity?

Users that add liquidity earn a percentage of each trade, proportionate to their ownership of the liquidity pool. This fee varies and can be seen in the buy/sell widget. For example, Alice owns $1,000 of liquidity in a $10,000 pool with a 2% LP fee. Bob buys $5,000 worth of tokens, which means Alice would earn $10 (5,000 * 0.02 * (1,000/10,000)).

There is also an incentive to provide liquidity for the public good. Many people visit the site to see the probability of events that matter to them. The more liquidity that is provided, the more participants will participate in the market, increasing the accuracy of the data.

How do I know how many liquidity shares I will get?

The number of LP shares you receive depends on the price of the outcomes. The more one-sided a market is, the fewer LP shares you will receive per dollar (see diagram below). Instead of receiving LP shares, you will get compensated in outcome tokens of the most probable event.

Are there any risks to adding liquidity?

Adding liquidity to markets can be very rewarding but requires management to prevent losses. The greatest risk to an LP is when prices shift dramatically, causing the outcome tokens to lose value.

For example, Bob adds $100 USDC to the liquidity pool when YES is $0.90 and NO is $0.10. He gets 10 LP tokens and $90 worth of YES. If the price of YES suddenly changes to $0.50, Bob's YES tokens are now only worth $50, resulting in a 40% loss.

I received an error when I tried to remove my liquidity. What do I do?

Purchase $1 worth of outcome tokens in the market and try removing your liquidity again. If your problem persists, please contact us on Discord or Intercom.

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