Prediction Market, Bot Trading Expansion... Vulnerable to Short-Term BTC Market Manipulation

On the 29th, Danning Sui, Research Director at Pantera Capital, presented at 'Ethereum Korea One: Genesis · Build Beyond the Narrative' held at the Informal Square in Seongsu, Seoul. Source: Park Jae-yeon/Digital Asset

The prediction market is rapidly growing, but a significant portion of actual trading volume is concentrated among a small number of professional traders and automated bots. In particular, there are concerns that trades may occur in prediction markets that aim to influence the reference price at the market's closing time for short-term fluctuations in BTC (Bitcoin) prices.

On the 29th, Danning Sui, Research Director at Pantera Capital, revealed the results of an analysis of trading and user data from prediction market platforms at the event.

Director Sui explained, "Platforms like Polymarket and Kalshi have been rapidly growing recently, with the sports and digital asset price prediction markets serving as major revenue sources due to their high trading turnover."

He added, "The sports and digital asset markets are key drivers of growth and revenue for many platforms due to their high turnover."

Director Sui further stated that based on on-chain data from Polymarket International, he analyzed the trading behaviors of approximately 2 million active wallets in the first half of this year.

The analysis classified accounts that executed more than 100 trades a day or traded in markets with over 1,000 participants as having a high likelihood of automated trading. In contrast, accounts that concentrated on trading over $50,000 (approximately 67.85 million KRW) in specific areas were categorized as professional or information-based traders.

According to Director Sui, about 89% of the analyzed wallets exhibited trading behaviors similar to retail users, but they accounted for only about 20% of the trading volume. In contrast, the majority of the trading volume was generated by a relatively small number of automated and professional trading accounts.

Bot activity was particularly prominent in the digital asset price prediction markets. Many wallets exhibiting trading patterns similar to bots were found in markets predicting short-term price increases and decreases for BTC and ETH (Ethereum), and automated trading was also observed in sports and weather prediction markets.

Director Sui stated, "The trading volume is largely driven by a small number of participants."

There are also concerns that the high trading volume in prediction markets does not accurately reflect actual user demand. Director Sui explained, "If platforms induce trading by rebating a significant portion of transaction fees to market makers, the effective trading costs can be significantly lowered, inflating the trading volume."

He noted that after incentive programs like market maker rebates were changed on Polymarket, there was a decrease in trading volume, stating, "Such trading volumes are not sustainable and respond very elastically to incentives."

Therefore, when evaluating prediction market platforms, it is important to consider not only the simple trading volume but also the open interest and trading volume together. This is because a small amount of capital trading repeatedly can lead to an overestimation of the actual market size.

Director Sui observed trading patterns suggesting the possibility of price manipulation in short-term markets predicting whether the BTC price will be higher or lower in 5 or 15 minutes.

He noted that by comparing the BTC price and trading volume on Binance with the start and end times of Polymarket's short-term markets, a pattern emerged where BTC trading volume and price temporarily fluctuated significantly just before and after the closure of certain markets, quickly returning to original levels.

Director Sui explained that this pattern was particularly observed after the introduction of Polymarket's 5-minute markets.

His hypothesis suggests that participants in the prediction market may buy BTC in the spot market just before the market closes to raise the reference price and then immediately sell BTC once the prediction market results are confirmed.

Director Sui explained, "By moving the price just before the market closes, they can influence the final price and market results, and once the results are determined, they can immediately sell Bitcoin." However, this is a hypothesis based on patterns observed in trading data.

There is also an analysis suggesting that short-term prediction markets may be more vulnerable to such trading. According to Director Sui, BTC has a relatively small average price fluctuation over 5 minutes, meaning that the capital needed to influence the closing price may be less than in long-term markets. He explained that 81% of the analyzed 5-minute markets had a price difference of within 0.05% between the starting and closing prices.

He suggested that to mitigate such issues, using a time-weighted average price (TWAP) method that reflects prices over a certain period instead of a single point in time could be an alternative.

Director Sui noted that Polymarket is moving towards a TWAP standard that aggregates prices over a short period rather than a single price point, calling it "an improvement that makes the market more robust against potential manipulation and value extraction."

He added, "Market design can actually change user behavior," emphasizing the need for further research analyzing insider trading and abnormal trading within prediction markets.

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