Guide
Market making on Polymarket: a practical guide
Market making on Polymarket means placing bid and ask quotes to earn the spread. This guide covers spread management, inventory risk, quote sizing, adverse selection, and P&L dynamics.
What this guide covers
- Market making earns the spread by providing bid and ask quotes
- Spread management balances profit against adverse selection risk
- Inventory risk grows when your position becomes one-sided
- Quote sizing should account for available depth and market volatility
What market making is
Market making is the practice of placing both buy (bid) and sell (ask) quotes simultaneously. You earn the spread on each round-trip trade.
On Polymarket, market making means quoting both the Up and Down outcome tokens. You buy tokens from sellers at your bid price and sell tokens to buyers at your ask price.
Market making is essential for market quality. Without market makers, traders would have no one to trade against.
The challenge is managing risk. Market makers can lose money if the market moves against their position (adverse selection) or if they accumulate too much inventory.
Spread management
The spread is your profit margin. A wider spread means more profit per trade but fewer trades. A narrower spread means more trades but less profit per trade.
Set your spread based on market volatility and inventory risk. In volatile markets, widen your spread. In stable markets, narrow your spread to attract more flow.
Dynamically adjust your spread as conditions change. Widen when you detect large incoming orders. Narrow when the book is balanced and volatility is low.
A common approach is to set spread as a function of inventory: spread = base_spread + k * abs(inventory). This naturally widens when your position grows.
Inventory risk and quote sizing
Inventory risk is the risk that the market moves against your accumulated position. If you have bought 500 Up tokens and the market resolves Down, you lose the entire position.
Keep inventory balanced. If your inventory is one-sided, adjust your quotes to attract the opposite flow.
Quote sizing determines how much liquidity you provide at each level. Smaller quotes are safer but earn less. Larger quotes earn more but increase inventory risk.
A common rule of thumb: size your quotes so that a single fill does not exceed 10 to 20% of your maximum acceptable inventory.
Adverse selection and P&L dynamics
Adverse selection occurs when informed traders consistently buy from you at prices below the true value and sell to you at prices above the true value.
On Polymarket, adverse selection is most acute near resolution when information about the outcome is most valuable. Traders who know the outcome will trade aggressively against your quotes.
Your P&L as a market maker is: total spread earned minus adverse selection losses minus fees. In a well-functioning market, spread earned exceeds adverse selection losses.
Monitor your fill quality. If you are consistently filled on the losing side, your quotes are too aggressive and you are being adversely selected.
Code examples
class MarketMaker:
def __init__(self, max_inventory=1000, base_spread=0.015):
self.inventory = 0
self.max_inventory = max_inventory
self.base_spread = base_spread
def get_quotes(self, mid_price):
inv_ratio = abs(self.inventory) / self.max_inventory
spread = self.base_spread * (1 + 2 * inv_ratio)
bid = mid_price - spread / 2
ask = mid_price + spread / 2
# Skew quotes to reduce inventory
if self.inventory > 0:
bid -= 0.005
ask -= 0.005
elif self.inventory < 0:
bid += 0.005
ask += 0.005
return {"bid": bid, "ask": ask}Free tier
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FAQ
How much can market makers earn?
It depends on spread width and volume. In active BTC 5-minute markets, market makers can earn 0.5 to 2 cents per round-trip trade, multiplied by volume.
What is the minimum capital to market make?
You need enough capital to provide meaningful quotes on both sides. For Polymarket prediction markets, $500 to $1,000 is a reasonable starting point.
How do I manage inventory risk?
Adjust your quotes to attract the opposite flow when your inventory is one-sided. Widen your spread as inventory grows. Consider hedging on correlated markets.
What are the biggest risks for market makers?
Adverse selection (trading against informed flow), inventory risk (market moves against your position), and operational risk (latency, system failures).