The problem isn’t what you’re missing Chris, it’s what readers might be missing when they see certain phrases — which by now have been clarified by these comments.

I mean something pretty specific when I say it. What’s missing from my understanding or from the discussion? Just that it’s a disadvantage that the price doesn’t move quickly enough some of the time? I’ll grant that it doesn’t move quickly; I remain to be convinced that it’s a disadvantage. What else are we missing?

Yes, but there’s a difference between deciding to endow a market maker (permanent decision) and deciding moment-by-moment whether to keep orders on the book.

“A contract could obligate a CDA market-maker.”

Ah. Yes. In real-money markets, there are often parties with obligations to make markets through thick and thin. I’m not sure what the details are when the market goes south, but I agree that in all normal times, there will be orders available. The price can move precipitously, which you appear to think is an advantage (I’m not calling it a disadvantage, I just don’t see requiring trading to move the price of an AMM a long way as a problem.) Of course, this isn’t a distinction between real- and play-money, just a facet of some markets that hasn’t been seen as important in others yet.

So the interesting thing about adding a market maker to a CDA in my mind is whether it’s built into the market or provided externally. The first effect is that in volatile times, you want the market maker to have priority access so the other traders don’t pre-empt him/her/it when times are toughest. And from the MM’s point of view, it may be crucial to have access to every trade in order to enable it to follow rules that constrain its losses. So I prefer a built-in MM. Zocalo supports (binary) markets with both a CDA and an AMM. There’s no reason other markets couldn’t do the same. It would be straightforward to implement other algorithms than the LMSR. But a manual MM wouldn’t be able to provide the same assurances to traders and wouldn’t be able to constrain its own expenses.

To the extent that traders can’t move the price very much, the information extraction may be compromised. There may be very good reasons why bids and offers evaporate at certain times in CDAs.. but I am not debating CDA vs LMSR. I was just observing that phrases like “unlimited liquidity” seem to be bandied about in unexamined ways in PM circles with surprising persistence.

As to the distinction that Michael points out, I’d push it a little farther. In a thick market and normal circumstances, you can be reasonably sure that you’ll be able to buy without moving the price very far, but come exceptional times, and the liquidity may dry up. With the LMSR (and most other AMMs) the AMM doesn’t change it’s policy in volatile times. You can always buy without moving the price very much. In fact, the amount the price moves is constant over time. In volatile times and with a thin market, the price may move a long distance because the next available book order is not near by. No guarantees for the trader.

I have screen shots from November 2005 that show some markets that definitely didn’t have market makers and other markets that look like they probably did have an AMM. Some multi-outcome markets had commodities with no available offers; I can’t think of a reason to design an AMM that would do this. Other multi-outcome markets had a consistent bid-ask spread across all the offers. (.59 in one market, .99 in another) I don’t recognize the AMM algorithm, but this looks likely to have been automatic. I don’t remember trading to find out whether book orders were allowed in these markets, or whether it was a pure AMM.

The LMSR provides unlimited liquidity in the first sense, in that an AMM implementing the LMSR stands ready to convert assets to money (or money to assets) at any time.

The real money/play money distinction only affects whether the sponsor of the LMSR AMM provides the subsidy in real or play money. Nothing inherent in the LMSR depends upon the real money/play money distinction.