How Prediction Markets Work: From Creation to Settlement Explained

Understanding how prediction markets work is like understanding how stock markets discover prices—except instead of valuing companies, you’re forecasting real-world events. When the 2024 presidential election showed prediction markets correctly projecting Trump’s victory at 57-62% while traditional polls showed a dead heat, it demonstrated these markets’ consistent ability to outperform expert analysis.

This guide explains the complete mechanics: market creation, trading systems, price discovery, and final settlement. By understanding these mechanics, you’ll know why prediction markets often beat polls, how prices reflect probabilities, and what happens from your first trade to final payout. If you’re new to prediction markets, start with our beginner’s guide to what prediction markets are first.

Stage 1: How Prediction Markets Are Created

Before anyone can trade, someone must create the market. The creation process determines everything from resolution criteria to market legitimacy.

Who Creates Markets and Market Structure

Market creation authority varies by platform. On Kalshi, all markets are created by the platform team and approved by the CFTC—in 2024, Kalshi became the first fully regulated platform in over a century to offer legal election trading in the United States. On Polymarket, anyone can propose a market through governance approval, enabling wider variety but requiring robust resolution protocols.

A well-structured prediction market needs five components: clear event definition (“Will Bitcoin close above $100,000 on December 31, 2025?” works; “Will the economy improve?” doesn’t), binary or multi-outcome structure, defined end date and deadline, resolution source specification (Yahoo Finance, FOMC statements, AP/Reuters), and collateral requirements (Polymarket uses USDC; Kalshi uses USD).

Markets typically open at $0.50 for YES and NO shares, implying 50/50 odds. Platforms seed initial liquidity for immediate trading. Fee structures: Polymarket US charges 0.01% on trades, Polymarket International charges 2% on net profits, Kalshi charges ~$0.01 per contract.

Markets fall into several categories: time-bound events, conditional outcomes, continuous range markets, and tournament-style markets. The 2024 presidential election market on Polymarket exemplified proper structure: created months in advance, clear resolution via AP/Reuters calls, and unambiguous timing. Federal Reserve markets on Kalshi launch 8 weeks before FOMC meetings and resolve within hours of the official statement.

Red Flags in Market Creation

Avoid markets with vague resolution criteria, distant end dates with no updates, unclear data sources, or no verifiable resolution method. Markets asking “Will aliens be discovered by 2030?” create impossible resolution challenges.

Stage 2: How Trading Works in Prediction Markets

Prediction markets use the same mechanics as stock markets: order books match buyers and sellers, and prices move based on supply and demand.

The Order Book and Trade Execution

Every prediction market has an order book—a digital ledger of buy orders (bids) and sell orders (asks). When buying YES shares on “Will Trump win 2028?” you see bids (highest: $0.68), asks (lowest: $0.70), and the spread ($0.02). Tight spreads mean liquid markets; wide spreads mean illiquid markets.

You have two execution options: market orders (instant execution at best price) and limit orders (set your price and wait). Most casual traders use market orders; professionals use limit orders to save on spreads.

Complete Trade Example

Trader Alice believes Trump will win the 2028 election. She buys 100 YES shares at $0.45, investing $45 total. If Trump wins, each share pays $1.00 ($100 payout, $55 profit, 122% return). If he loses, shares pay $0.00 (total loss: $45).

Markets are dynamic. If Trump’s odds improve to $0.60, Alice can sell immediately. She sells 100 shares at $0.60, receiving $60. Her profit: $15 (33% gain) locked in immediately, eliminating outcome risk.

Price Movement and Platform Differences

Prices follow supply and demand. New information triggers buying pressure, pushing prices from $0.45 to $0.55. High-volume markets (greater than $10 million) absorb large trades smoothly. Low-volume markets can jump 10-20% on single trades. When assassination attempt news broke in July 2024, political markets saw immediate 15-20% swings.

Platform implementations: Polymarket uses blockchain settlement (USDC on Polygon, 0.01% US / 2% international fees). Kalshi operates as CFTC-regulated exchange (USD settlement, ~$0.01 per contract). PredictIt has $850 max position with 5% profit fee plus 5% withdrawal fee.

Examples: Buy 50 Bitcoin $100K YES at $0.60 ($30), price rises to $0.75, sell for $37.50 ($7.50 profit, 25% gain). Or buy Federal Reserve “no rate cut” at $0.30, Fed keeps rates unchanged, shares resolve to $1.00 ($0.70 profit, 233% return).

Stage 3: How Markets Discover Accurate Probabilities

The remarkable aspect isn’t just trading mechanics—it’s that prices reflect surprisingly accurate probability estimates.

Price Equals Probability

A share trading at $0.70 implies 70% probability because it pays $1.00 if YES occurs. If price is $0.70 but true probability is 80%, smart traders buy, driving price toward $0.80. If price is $0.70 but true probability is 60%, rational traders sell, pushing price down. Price stabilizes when no obvious profit opportunity remains.

Collective Intelligence and Information Integration

Individual traders have biases, but aggregated prices capture collective knowledge. One trader follows polls, another reads betting lines, another analyzes historical data—all perspectives flow into a single price. Real-money stakes force honest assessment. Self-correction works: losing traders exit, winning traders increase positions.

The 2024 election markets synthesized polling, historical trends, betting markets, and real-time news into probability estimates updating minute-by-minute. With combined monthly volumes reaching $4.5 billion in October 2025 across Polymarket and Kalshi, these represented the largest forecasting experiment in history.

Watch information processing: 9:00 AM—Trump market at $0.48. 9:05 AM—Major poll shows Trump +3 in Pennsylvania. 9:10 AM—Traders buy YES, price moves to $0.52. 9:30 AM—Equilibrium at $0.51. This happens continuously across thousands of traders.

Why Markets Beat Polls

Four factors explain superior accuracy: Skin in the game (traders lose money for mistakes; pollsters face no cost). Real-time updates (polls take days/weeks; markets update instantly). Synthesizing inputs (markets combine polls, fundamentals, sentiment; polls measure single snapshots). Historical evidence (2018-2020 research showed PredictIt more accurate than FiveThirtyEight; in 2024, markets showed Trump at 57-62% while polls showed toss-up).

Federal Reserve markets exceed $50 million volume with predictions within 5% of actual decisions because professional economists trade with deep expertise.

Why Market Prices Beat Individual Predictions

The market aggregates your knowledge PLUS everyone else’s. Unless you have truly unique information, the market price is likely more accurate than your forecast.

Market Limitations

Markets aren’t infallible. Thin markets (less than $10,000 traded) can be manipulated. Herding behavior creates temporary bubbles (the “red wave” before 2022 midterms). Information cascades trigger bandwagon effects. Black swan events shock unprepared markets. The Iowa Electronic Markets correctly predicted presidential outcomes for decades but picked Harris in 2024 (6% error versus 1.3% historical average).

Stage 4: How Markets Resolve and Payouts Work

After weeks, months, or years of trading, every market must resolve.

Resolution Timing and Sources

Trading closes before resolution begins. Election markets close on election day, not when results are certified weeks later. The sequence: event occurs → verification → market resolves → payouts distributed.

Sports markets resolve within hours using ESPN or official statistics (Super Bowl markets resolve within 10 minutes; Super Bowl 2025 trading exceeded $1.1 billion). Political markets wait days for official certification (2024 presidential election resolved ~24 hours after election day). Economic data markets resolve same-day (Federal Reserve markets resolve within hours of FOMC statement). Long-term markets can take years.

Resolution Verification and Payouts

Resolution sources provide objective verification. Stock prices use Yahoo Finance API. Weather uses NOAA data. Bitcoin markets reference Coinbase closing prices (Bitcoin markets exceeded $15.5 million volume in 2025).

Polymarket uses UMA Protocol’s Optimistic Oracle: validators stake tokens to verify outcomes. Outcomes enter a 2-hour challenge window. If unchallenged, payouts execute automatically. If challenged, UMA token holders vote.

Kalshi employs verification teams cross-referencing official sources under CFTC oversight (AP/Reuters for elections, federalreserve.gov for Fed, ESPN for sports).

Payout mechanics: YES wins means YES shares pay $1.00, NO shares pay $0.00. Example: You own 100 YES shares purchased at $0.45 ($45 invested). Market resolves YES. Gross payout: $100. Platform fee (2% on profit): ($100 – $45) × 2% = $1.10. Net payout: $98.90. Total profit: $53.90 (120% return).

Settlement speed: Polymarket credits USDC immediately via smart contracts (withdraw to bank takes 1-3 days). Kalshi credits USD immediately (withdraw in 1-2 days). PredictIt processes in 1-3 days with 5% withdrawal fee.

Disputes are rare (less than 0.5%) but can occur with ambiguous outcomes. On Polymarket, UMA token holders vote with bonds that can be slashed. On Kalshi, platform decisions are final under CFTC oversight.

Why Prediction Market Prices Actually Predict Outcomes

Understanding why these mechanics produce accurate forecasts requires examining economic theory and empirical evidence.

Incentive Structure and Market Efficiency

Prediction markets work because incentives align accuracy with profit. Making money requires being right. Money locked in incorrect predictions cannot be deployed elsewhere—rational traders optimize capital allocation. Professional traders must maintain accuracy or exhaust capital.

Minimal house edge (2% versus 5-10% sportsbook vigorish) makes accuracy profitable. If you know Trump has 60% chance but market shows 50%, buying YES at $0.50 offers +10 percentage point edge that compounds over dozens of trades.

Market efficiency theory states prices reflect all available information. If Polymarket shows 65% Trump while Kalshi shows 55%, arbitrageurs buy Kalshi at $0.55 and sell Polymarket at $0.65, pocketing $0.10 per share, forcing convergence toward true probability.

Academic Evidence and Failure Cases

Presidential elections (2000-2024): Iowa Electronic Markets showed prediction markets outperformed polls in 6 of 7 cycles. The 2024 election—where markets correctly showed Trump ahead at 57-62% while polls indicated toss-up—validated this pattern. CNN reported prediction markets “proved far more accurate than the most highly regarded polls.”

Sports outcomes: Markets match Las Vegas betting lines within 1-2 percentage points. Corporate forecasting: Google and Microsoft internal prediction markets improved forecast accuracy by 15-25% versus expert surveys. Federal Reserve decisions: Markets demonstrate exceptional accuracy, typically within 5% of actual decision.

When markets fail: Low liquidity (less than $10,000 volume) allows manipulation—single traders can move prices 10-20%. Emotional trading creates temporary bubbles. Time horizon challenges make long-dated markets (5+ years) less accurate. Coordinated manipulation can temporarily distort prices. Groupthink infects traders when everyone reads same polls.

The Bottom Line on Accuracy

Prediction markets aren’t magic. They’re accurate when rational actors with financial incentives aggregate diverse information efficiently. When conditions break down—through low liquidity, asymmetric information, irrational exuberance, or genuine uncertainty—accuracy suffers. Markets are typically more accurate than alternatives, not perfect in absolute terms.

Complete Example: Trading a Presidential Election Market

To see how everything fits together, let’s walk through a presidential election market’s complete lifecycle.

Market Creation (January 2027): Polymarket creates “Will the Democratic candidate win the 2028 US Presidential election?” Resolution: AP and Reuters calls. Initial price: $0.50 YES / $0.50 NO.

Early Trading (January-June 2027): Light trading, prices drift $0.45-$0.55. Volume averages $500,000-$1 million weekly. In June, Trader Bob buys 200 YES at $0.48, investing $96. Thesis: “Incumbency plus strong economy favors Democrats 52-55%. Market underprices this.”

Primary Season (July-December 2027): Primaries increase volatility. Prices swing $0.42-$0.58. Moderate Democrat wins nomination in November, price jumps to $0.56. Bob’s position appreciates to $0.52 (8.3% gain). Volume increases 10x to $5-$10 million.

General Election (January-October 2028): Prices range $0.50-$0.65 as polls fluctuate. June debate: Democrat performs well, price spikes to $0.63. August inflation report: Price falls to $0.55. October: Bob sells 200 shares at $0.60 for $120. After 2% fee, net profit: $23.52 (24.5% return over 16 months).

Election Day and Resolution (November 2028): November 5—trading closes midnight EST. Final price: $0.61. November 7—AP and Reuters call race for Democrat (51.3% popular vote, 291 electoral votes). Market resolves: YES = $1.00, NO = $0.00. Smart contracts execute settlement within minutes.

Key Takeaways: Markets operate for months/years before resolution. Prices fluctuate on new information. Traders can exit early to lock profits. Settlement happens automatically and quickly.

Frequently Asked Questions About How Prediction Markets Work

Can I lose more money than I invest?

No. If you buy 100 YES shares at $0.50 ($50 invested), maximum loss is $50. You cannot lose more than initial investment, unlike margin trading or options where losses can exceed principal.

How do prediction markets make money if there’s no house edge?

Platforms charge small fees on net profits or monetize via alternative methods. Polymarket International takes 2% of winning trades only. Polymarket US charges 0.01% on trades. Kalshi charges ~$0.01 per contract and monetizes through order flow. PredictIt charges 5% on profits plus 5% withdrawal fees.

What happens if I want to exit a position before the market resolves?

You can sell shares at current market price anytime. Example: You bought YES at $0.40, current price is $0.60, you sell for $0.60, locking in $0.20 per share profit immediately.

How quickly do prices update when news breaks?

Very quickly—usually within seconds to minutes. High-liquidity markets see prices move 5-20% within 60 seconds of breaking news. This is faster than polls (taking days) and roughly as fast as stock market reactions.

Can prediction markets be manipulated?

Large, liquid markets (greater than $10 million volume) are very difficult to manipulate because it requires significant capital with no guaranteed return. However, small markets (less than $100,000 volume) can be pushed around. Learn more in our liquidity guide.

What if the outcome is disputed or unclear?

Each platform has resolution protocols. Kalshi uses verification teams with CFTC oversight. Polymarket uses UMA Protocol, where validators can dispute within a 2-hour challenge window. Disputes are rare (less than 0.5%) but can delay payouts.

Do I need to understand blockchain to trade on Polymarket?

No. While Polymarket runs on Polygon blockchain, user experience resembles traditional platforms. You deposit USDC, trade with clicks, and withdraw via exchange. You need a crypto wallet (MetaMask) and should understand basic wallet security. Check our complete Polymarket guide.

How do market makers provide liquidity?

Market makers place both buy and sell orders continuously, ensuring there’s always someone to trade with. They profit from bid-ask spread: buy at $0.49, sell at $0.51, pocket $0.02 per share. This provides liquidity so traders enter and exit quickly.

Understanding the Mechanics: Your Next Steps

Prediction markets work through a four-stage process: markets are created with clear resolution criteria, traders buy and sell shares through order books, prices reflect collective probability estimates via supply and demand, and markets resolve based on verifiable outcomes. Financial incentives align accuracy with profit—when traders risk real money, they assess probabilities honestly, producing estimates that often surpass expert forecasts.

Ready to start trading? Read our step-by-step beginner’s guide to trading prediction markets.

Want to compare platforms? See our complete comparison of Polymarket, Kalshi, and PredictIt.

Curious about accuracy? Dive into our research-based analysis of prediction market accuracy vs polls.

Developing strategies? Explore our guide to prediction market trading strategies.

Understanding odds? Check our guide to prediction market odds explained.

Questions about legality? Read our comprehensive guide on prediction market legality.