I don't know if understand your preorder idea. If the orders are placed but don't execute how will the market maker adjust the price?
The market maker won't adjust the price until it opens its doors.
If it doesn't adjust the price doesn't that mean all preorder buyers will be forced to buy at a price of 0.33 BitUSD/{A,B,C} for all three assets?
Yes, but only the first $1 (actually, the math effectively uses infinitesimal fractions, so it's more like 1 satoshi) will execute at that price. If people only buy A and B at that price, then A and B will start to rise and C will start to fall. Then eventually either A or B will be pushed to a price that exceeds what people are willing to pay (or buy orders for them will run out of money). Likewise C may fall cheap enough that buy orders for C become active (there may be takers for C willing to pay $0.05 or $0.03 or $0.001).
But what if the market's prior expectation of the probabilities for the three outcomes is not uniform?
What I mean by the market maker being "dumb" is that his prior expectation for the probabilities is
always uniform. Then he updates those prices based on the total of what he's bought and sold and how much money he has left to help pay out winners (if someone buys a million tickets when the market maker only has $1000, the tickets might cost $0.9997 each and most of the payout will be the buyer getting his own money back, but the market maker does "help" by adding $1,000,000 - $999,700 = $300 to the pool).
That means people only buy the assets corresponding to outcomes with better than uniform probabilities at a nice discount price (granted at the cost that 5% of their orders will instead be forced into a speculative asset which gets its value from the outcome being contrary to the market's expectation of the outcome immediately prior to the outcome being known to the blockchain).
Yes, this is true -- but the discount quickly vanishes after only a small fraction of the orders are filled, because the market maker's funds dwindle.
That brings up another question. Won't the market always adjust to make the true outcome most favorable faster than a super majority of the judges can put the outcome into the blockchain?
Yes. If everyone saw on TV that Ron Paul won, but it'll be a few days before the official result comes in and the judges input it into the blockchain, then everybody'll be buying C at $0.99 and trying to unload A or B at $0.001. The $0.01 discount on C would be basically because some people with C might want the convenience of cashing out now instead of in a few days, and they want it so bad they're offering to give 1% of their payout to somebody else if that's what it takes to make it happen. The A and B assets would probably be completely illiquid -- whoever ended up with them is stuck with the assets and their $0 payout, because the supply of fools willing to buy assets known to be worthless is usually quite limited, and all the people willing to sell to them at any price will quickly part them from their money.
In other words, while we're watching who various states went for on TV, people will be trying to buy the winner before he's all the way in the $0.90 range and sell the loser before he's totally worthless. They'll be trading to contrarians, people trying to sell an overvalued lead horse and trying to pick up shares in the underdog on the cheap. In the course of those madly gyrating market conditions, somebody will end up with all those A and B shares and be unable to unload them, their orders will go unfilled and they'll end up with worthless assets. Traders who prefer a calmer style could simply pick their horse at more stable prices earlier in the week, then simply hold the shares until it's all over.
So isn't the market maker pretty much always going to lose?
Yes. Which is why in the paper he suggests it be funded by someone who derives value from having the prediction, because they can expect a loss from funding the market maker.
I say the market maker should be funded by equity investors, and everyone who places a pre-order becomes an equity investor in the amount of 5% of their order. Everyone who places a pre-order gets a piece of the action when the market maker has their dumb initial position with A, B, C all at $0.34. The +EV of that piece cancels out the -EV of investing in someone who only makes money when a free market
doesn't work. It
has to cancel because there's nowhere else for the money to go!