Price Discovery

The process by which market trading determines the price of a digital asset, reflecting the collective probability of an event’s outcome.

What is Price Discovery?

Price discovery is the mechanism through which the trading of digital assets in a prediction market establishes a price that reflects the collective expectations of participants about the likelihood of a specific event. As Scott Kominers explains in the transcript, when participants buy or sell assets based on their private forecasts (e.g., a 70% chance of a candidate winning), their actions push the asset’s price toward a value that aggregates these beliefs, such as $0.70 per asset. This process mirrors how financial or commodities markets determine prices, but in prediction markets, the price directly corresponds to the probability of an event occurring.

For example, in the 2024 U.S. presidential election, prediction markets like Polymarket saw asset prices for candidates adjust dynamically as participants incorporated new information, such as local polls or economic indicators, outperforming traditional polls with low response rates (e.g., 5%). The accuracy of price discovery depends on market thickness—more participants with diverse information lead to better price signals. However, distortions like manipulation or herd behavior can skew prices, as seen in historical cases like the 2016 election where thin markets underestimated certain outcomes.

Price discovery in prediction markets is a powerful tool because it translates dispersed knowledge into a single, interpretable metric—the price. This makes it valuable for forecasting events like elections or corporate outcomes and for extracting insights from correlated markets, such as oil prices signaling Middle East conflicts, as noted by Alex Tabarrok.