How do liquidity providers earn fees in on-chain prediction markets?

30 September 2026

Liquidity providers (LPs) in on-chain prediction markets earn fees by depositing collateral into automated market maker (AMM) pools that facilitate trading of outcome shares. When traders swap shares in these pools, a small fee is charged on each trade, and that fee is distributed proportionally to LPs based on their share of the pool. The process is straightforward but relies on understanding how conditional tokens and AMM mechanics interact.

The core mechanism: fees from trading

When you supply liquidity to a prediction market pool, you are effectively providing both sides of a binary outcome - typically "Yes" and "No" shares - in equal value. Traders buy and sell these shares through the AMM, and each trade incurs a fee, usually between 0.1% and 0.5% of the trade volume. This fee accumulates in the pool and increases the total value of the liquidity tokens you hold. When you withdraw, you receive a larger share of the pool than you deposited, representing your earned fees.

How liquidity provision works step by step

1. Choose a market and pool. On platforms like Polymarket, each prediction market has one or more liquidity pools tied to specific outcome tokens. You must decide which market to support.

2. Deposit equal value of both outcomes. To provide liquidity, you need to deposit an equal dollar value of "Yes" and "No" shares. For example, if the current price is 60 cents for Yes and 40 cents for No, you would deposit $60 worth of Yes and $60 worth of No to maintain balance. This ensures the pool is balanced and minimizes impermanent loss risk.

3. Receive liquidity tokens. The protocol mints liquidity tokens representing your proportional ownership of the pool. These tokens accrue value as fees are collected.

4. Earn fees from every trade. Each time a trader swaps shares in the pool, the AMM applies a fee. The fee is added directly to the pool's total value, increasing the redemption value of each liquidity token. You do not need to claim fees separately - they compound into your position automatically.

5. Withdraw at any time. You can remove your liquidity by burning your liquidity tokens. You receive the current proportional value of the pool, which includes your original deposit plus any fees earned minus any impermanent loss.

Why fees vary between markets

• Trade volume. High-volume markets generate more fees because more trades occur. Popular events like elections or major sports matches attract frequent trading.
• Fee rate. Each pool has a fixed fee percentage set by the market creator or protocol. Higher fees can mean more earnings per trade but may discourage trading volume.
• Pool depth. A deeper pool with more liquidity will earn a smaller share of each trade's fee per LP, but the trade volume may be higher because slippage is lower. Shallow pools earn more fee per trade but attract less volume.

Impermanent loss: the real cost of providing liquidity

LPs do not earn fees risk-free. The main risk is impermanent loss, which occurs when the relative price of "Yes" and "No" shares shifts significantly after you deposit. Because you deposited equal values, if one outcome becomes extremely likely (e.g., Yes price rises to 95 cents), the arbitrage trader will buy your Yes shares cheaply and sell you No shares, leaving you heavily weighted in the losing side. When you withdraw, you may receive less total value than if you had simply held USDC.

Impermanent loss is permanent once you withdraw. The only way to offset it is through accumulated fees. If fees are high enough, they can outweigh the loss, but that is not guaranteed. Low-volume markets often produce insufficient fees to compensate.

How to estimate fee earnings

You can approximate earnings using the pool's total value locked (TVL) and daily trading volume. For a pool with a 0.3% fee and $1 million in TVL, if daily volume is $100,000, the daily fee pool is $300. If you own 1% of the pool, you earn roughly $3 per day. That same $10,000 deposit (1% of TVL) would earn $3 daily. Check the market's historical volume and fee rate on the platform's analytics page before committing.

When providing liquidity makes sense

• Balanced markets. Markets where the probability stays near 50/50 for most of the duration minimize impermanent loss because share prices do not drift far.
• High volume markets. Elections, major sports events, or regulatory decisions that generate sustained trading activity.
• Short time horizons. The less time until the market resolves, the less chance for price swings that cause impermanent loss.

Key Practical Points

• You must provide liquidity in the same collateral token the market uses (USDC or DAI). You cannot mix.
• Some platforms allow single-sided liquidity provision through partner protocols, but this introduces additional complexity and risk.
• Liquidity tokens are tradable on secondary markets, but liquidity is often thin.
• When the market resolves, the pool is settled. You must claim your collateral manually after resolution - it does not automatically return to your wallet.

Liquidity provision in prediction markets is not passive income. It requires active monitoring of price movements, volume, and the market's resolution date. Fees can be attractive, but impermanent loss is a real cost that can erase them. Always compare expected fee earnings against the risk of holding a lopsided position at withdrawal.

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