How to design a secure prediction market

Prediction markets are one of the most interesting applications in DeFi. They allow users to bet on the outcome of real-world events, creating efficient price discovery mechanisms for everything from election results to sports outcomes.

But designing a secure prediction market is harder than it looks. There are several attack vectors you need to consider, from oracle manipulation to front-running to collusion between market makers.

The first thing to get right is your oracle design. Most prediction markets rely on external data to resolve outcomes. If an attacker can manipulate this data, they can steal funds from the protocol. We recommend using a combination of decentralized oracles like UMA's optimistic oracle with a dispute resolution mechanism.

Front-running is another major concern. In a prediction market, users who can see pending transactions have an unfair advantage. They can place bets right before the outcome is known. To prevent this, implement commit-reveal schemes where users first commit to their bet (by submitting a hash), then reveal it later.

Liquidity design matters too. AMM-based prediction markets need careful thought about their bonding curves. A simple constant product curve might not work well for binary outcomes. Consider using LMSR (Logarithmic Market Scoring Rule) or other specialized curves designed for prediction markets.

Finally, think about your settlement mechanism. What happens when an outcome is disputed? How do you handle edge cases like canceled events? Having a clear governance process for these situations is essential.