What are Prediction Markets?

Introduction

Regarding cryptocurrencies, there is a known element of volatility in prices and trading. This is true for fast-paced markets, and it adds a level of complexity for investors, such as the need to interpret finances, technology, and human behavior to predict each different movement. For that reason, accurately predicting events can be a very valuable ability. This is where prediction markets come into play.

What are Prediction Markets?

Prediction markets are dynamic platforms where individuals can trade on the outcomes of upcoming events, ranging from the results of sports matches to the outcome of political elections or world events. Unlike traditional betting platforms, they gather the collective wisdom of participants to measure the likelihood of outcomes.

For instance, a person would like to try to guess the probability of their favorite sports team winning a match or predict the outcome of a major political decision, all through blockchain technology. Prediction markets are used precisely to facilitate this by providing a decentralized framework for speculation and forecasting.

An important concept of these markets is that they use prices as indicators of the perceived probability of each event occurring. By analyzing them, participants can gain insights into market sentiment and make informed decisions that are based on the aggregated beliefs of the community.

Regarding cryptocurrencies, they offer a unique opportunity to take advantage of the principles of decentralized finance (DeFi) and blockchain technology to try to predict and understand relevant future events.

How Do Prediction Markets Work?

Binary Options Markets and Price Dynamics

Binary option markets allow participants to trade by betting on the likelihood of a specific outcome occurring. Typically, they offer two possible outcomes, such as “yes” or “no,” or “win” or “lose,” with contracts expiring at either 0% or 100%, depending on the outcome.

The prices for these options fluctuate based on market sentiment and perceived probabilities. For instance, when the market believes that an event is highly likely to occur, the price of the corresponding binary option approaches 100%, indicating high confidence in the outcome. However, when the likelihood of an event is deemed low, the price of the binary option tends towards 0%.

Market dynamics play a crucial role in shaping binary option prices. As participants buy and sell contracts based on their predictions, the market adjusts accordingly, reflecting changes in sentiment, and new information is added. This continuous process of price discovery enables these markets to provide real-time insights into the collective beliefs of participants.

Prediction Markets vs. Traditional Derivatives Markets

While prediction markets share similarities with traditional derivatives markets, such as future analysis and options, key differences exist in their structure and the way they operate. Traditional derivatives markets often involve indirect bets on the future prices of assets, such as commodities or stocks, through complex financial instruments. On the other hand, prediction markets offer a more direct and transparent way to speculate on future events, allowing participants to trade binary options based on their predictions of specific outcomes.

Centralized vs. Decentralized Crypto Prediction Markets

Centralized prediction markets operate within the traditional finance framework and tend to be regulated by government or third-party organizations. These markets face several limitations that impact their effectiveness, such as the significant imposition of low betting limits on participants - which restricts their ability to express strong convictions about certain outcomes - such as requiring Know Your Customer (KYC) verification, which excludes potential participants from participating. They may skew market dynamics, favoring a big player’s private interests.

Another important point is that they often impose high fees, such as withdrawal fees, which might deter participation and reduce market efficiency for those who can afford it.

With that being said, it is a fair assessment that they face several challenges that limit their predictive power and accessibility to new investors. Low betting limits restrict participants from fully expressing their beliefs about certain outcomes, leading to potential mispricing and decreased efficiency. KYC requirements further limit participation by excluding individuals who prefer to remain anonymous or cannot meet overly bureaucratic verification criteria. High fees imposed by centralized markets reduce the attractiveness of the involvement and may deter potential users.

Decentralized crypto prediction markets

Decentralized crypto prediction markets offer a solution to the limitations of centralized markets by operating on blockchain technology without relying on intermediaries or central authorities. These markets use smart contracts to facilitate peer-to-peer betting on various events without the need for traditional financial infrastructure. In this scenario, participants can engage in prediction markets anonymously and without geographic restrictions, as decentralized platforms typically do not require KYC verification.

Decentralization can offer several benefits compared to centralized counterparts. A big one is that participants in these markets are not subject to low betting limits, allowing them to fully express their convictions about event outcomes without restrictions. Besides not requiring KYC verification, enabling broader participation from individuals who value privacy or lack identification documents, they also can feature lower fees compared to centralized markets. This enhances accessibility and attracts a wider user base.

Examples of Decentralized Crypto Prediction Markets

There are several platforms emerging in this market, each offering its own features and functionalities, creating a positive track record of accurately predicting real-world events, adding to the perception of their efficacy and reliability.

For instance, Augur, one of the first projects in this segment, was able to forecast the outcomes of various political elections, including the 2020 United States presidential election, with remarkable precision, demonstrating the platform’s ability to harness collective intelligence for insightful predictions. Similarly, Polymarket successfully predicted some COVID-19 statistics, providing a venue for relevant predictive power.

These platforms seem to effectively address the shortcomings of their centralized counterparts, and help create a more inclusive and accessible environment for prediction trading. Some notable Web 3 prediction markets are:

Augur

Augur is one of the pioneer projects in the segment of Web 3 Prediction Markets. Built on Ethereum, it is an open-source, peer-to-peer, decentralized, free-to-use protocol that allows any individual to create a market, to trade prediction shares on virtually any event.

It is important to note that Augur is not a prediction market itself. It is a software through which cryptocurrency users can run the Augur protocol to develop their own prediction markets through open-source smart contracts in the Ethereum blockchain.

One advantage of this protocol is that it is entirely decentralized. The Forecast Foundation, the developing team behind it, acts solely by providing updates and writing code for the open-source software, and it has no control or powers over markets created by users online - who are at the same time liable and responsible for the markets they create.

Polymarket

Polymarket is the largest Prediction Market to date. It allows users to bet on the possible outcome of future events on a series of different topics, from politics to pop culture. It has gained traction in the field of prediction markets for having a very user-friendly interface, where the probability of an outcome is traded as a price.

For instance, the image below, captured in February 2024, shows the prediction market of who will be nominated as Best Actor for the Oscars of that year. If a user wishes to bet that Cillian Murphy will be the nominated contestant, they will bet 73 cents on “yes,” which translates as a 73% chance of him being chosen for that category, based on the predictions of the community in that market.

Each binary alternative of “yes” or “no” can be bought as a share. If the user is correct in their assumption and Cillian Murphy is the winner of that year, then each “Yes” share will be worth $1, representing a $0,28 profit per share. Anyone who, in this scenario, voted “no” would have their shares invalidated. Another possibility in this scenario would be to trade shares in case they become more valuable by the market speculation.

Overall it presents interesting results that seem to correlate with real life events. An interesting example of that is that it correctly predicted the outcome of the 2020 United States presidential election.

Better Fan

Better Fan is a blockchain prediction game based on sports events that uses Fan Cards Non-Fungible Tokens (NFTs) to encourage users’ engagement and participation within the platform, establishing their daily prediction limits and staked amounts, based on the value and quantity of Fan Cards they possess.

Fan Cards are the central element of the Better Ecosystem. They determine users’ daily prediction limits and provide access to various game modes. Each card is easily minted and is available for purchase from the in-game marketplace, offering participants the means to enhance their predictive experience and trade with other blockchain cryptocurrencies.

Better Fans offers a gamified approach to sports betting, focusing on user experience, transparency, and security while maintaining the familiarity of traditional platforms. At the same time, it eliminates the harmful effects of traditional betting by eliminating the need for direct monetary bids. Instead, the use of Fan Cards delimit betting opportunities for users, allowing them to participate in prediction markets without the fear of financial loss.

In the event of an unsuccessful bet, users will simply have to wait for their betting limit to renew. This provides an incentive for continuous engagement with the Better Fan ecosystem.

Wingman

Wingman is a Polygon, sidechain-based, decentralized platform that can be used to predict flight delays. By using MATIC tokens to place binary bets on the likelihood of a plane to be delayed, users are able to win payouts, based on the probability stated when they bet.

The platform, then, uses real-world data from the website FlightStats.com to settle in real-time.

Wingman uses the MATIC token for users to place their bets and settle decisions. The developers, however, may launch a native token in the future, depending on how much the platform grows over time.

Why Prediction Markets Matter in Crypto

Decentralized prediction markets represent significant innovation in financial technology by offering an interesting new approach to forecasting future events and aggregating collective intelligence through bets.

These platforms enable individuals worldwide to participate in financial markets, games and prediction-based communities without relying on intermediaries or centralized authorities. This helps empower users from different backgrounds to engage in forecasting and trading activities, leveling the playing field and expanding inclusive opportunities, and bringing a more ethical approach to betting.

Prediction markets play a role in enhancing market efficiency by facilitating transparent and censorship-resistant opinion trading. By using blockchain technology, these platforms ensure that transactions are recorded on a safe, unchangeable, and unhackable public ledger, providing transparency, and accountability and mitigating the risk of censorship or manipulation by centralized entities.

In a world where in many places media and information are heavily manipulated by the stakeholders who have more pull with the market, Prediction Markets have the potential to also empower users to make decisions with a more accurate perception of reality. They offer a safe tool to manage exposure to risks (which can be both monetary or social), ranging from the user’s views on geopolitical events to financial market fluctuations. This contributes to overall financial stability and resilience against volatile environments, providing an objective perspective of how the majority of a community feels about an event analyzed.

They also encourage innovation within the cryptocurrency ecosystem. By incentivizing the creation of new prediction markets for a wide range of events, these platforms facilitate creativity and experimentation between users and developers, which can be hard to find within the traditional financial industry.

By removing barriers to entry, providing safer access to a range of opinions and offering a safer playing field, it empowers individuals to participate in forecasting and trading activities.

The Future of Prediction Markets

The future of decentralized prediction markets holds potential for advancements and innovations, especially those that take advantage of cryptocurrency technology. One particular field involves the integration of multi-chain solutions to enhance data accuracy and reliability, enabling prediction markets to access real-time information from external sources with greater efficiency.

Advancements in decentralized finance (DeFi) infrastructure, as well as markets that can operate within multiple blockchain protocols should also be able to make prediction market operations easier and more accessible to a wider range of users.

Conclusion

Prediction markets, whether centralized or decentralized, are able to represent a powerful tool for forecasting future events, financial expectations, and aggregating collective intelligence for outcomes. They have evolved from earlier forms of political betting into more sophisticated platforms that use blockchain technology in order to offer transparent, censorship-resistant, and inclusive trading environments, empowering users to bet and have a different perspective of major scenarios worldwide.