What is a prediction market: the power of crowdsourced wisdom

Prediction markets pose an age old question: are the many truly smarter than the few? With prediction markets like Polymarket and Drift Protocol’s Bullish on Everything (BET) making headlines and gaining popularity, this question is more relevant than ever. Featuring the ability to forecast everything from election results to stock prices, these crypto prediction market platforms allow individuals to trade contracts based on the potential outcome of future events while tapping into the collective wisdom of the crowd. As these markets continue to grow and evolve, they offer a fascinating glimpse into the potential of crowdsourced intelligence.

Curious as to how these prediction markets work and why they’re so popular among speculators? Read on as we cover how prediction markets are shaking up the DeFi space.

TL;DR

• Prediction markets let you trade contracts on future events, tapping into the “wisdom of the crowd” to predict elections, stock prices, and more.

• Factors like accessibility, transparency, diverse market options, blockchain innovation, and social engagement are driving the rise of prediction markets.

• Prediction markets offer contracts for a range of markets that cover everything from current affairs to weekend box office numbers.

• Platforms create contracts for events, set prices based on perceived likelihood, and settle bets with payouts for correct predictions.

• While some may be pessimistic about the future of prediction markets given Augur's rise and fall, these issues are being addressed with blockchain advancements, user-friendly interfaces, and emerging regulations that pave the way for continued growth and innovation.

What are prediction markets?

Prediction markets are online platforms that harness the collective wisdom of the crowd to forecast future events. Often referred to as information markets or prediction betting markets, these platforms allow participants to buy and sell contracts based on the anticipated outcomes of various events.

These events can span a wide range of topics, including political elections, sporting competitions, economic indicators, geopolitical events, and more. By trading contracts on these events, participants effectively bet on their predicted outcomes. The prices of these contracts fluctuate based on the perceived likelihood of each outcome, reflecting the collective wisdom of the market.

Why are prediction markets so popular?

Prediction markets offer a unique way to gauge public sentiment, potentially make speculative gains, and be used as a tool for overall risk management and decision-making. Their popularity can be attributed to several factors.

• Accessibility: Prediction markets are accessible to a wide range of individuals, from seasoned traders to newcomers. This is doubly so with how prediction markets these days make setting up predictions easy and fuss-free.

• Transparency: The prices of contracts in prediction markets are transparent, allowing participants to see the collective wisdom of the crowd. For example, a brief look at Polymarket’s elections forecast reveals an array of trending markets within the space that are ripe for users to participate in.

• Diversity: Prediction markets cover a wide range of events, providing opportunities for speculation and hedging across various sectors. As mentioned, this can range from serious geopolitical affairs predicting the next global conflict to lighthearted predictions that ask participants to measure a movie's opening weekend box office numbers.

• Innovation: Prediction markets are at the forefront of technological innovation, leveraging blockchain technology and smart contracts to create decentralized platforms. Decentralized predictions markets like Polymarket and BET are making use of their respective blockchains to entice users with speedy transactions and low-cost interactions.

• Social engagement: Prediction markets can foster a sense of community and social engagement as participants discuss and debate potential outcomes. Like how sports bettors collectively discuss the outcome of a game, we’re seeing a similar phenomenon here as users are objectively laying out their theses for certain outcomes.

Combined with the potential for financial gain, these factors have contributed to the growing popularity of prediction markets.

Types of prediction markets

Prediction markets can be typically classified into three main categories.

Financial markets

Financial markets are prediction markets that focus on predicting the future prices of assets and the possible actions and policies that may be enacted by government entities.

Political markets

Political markets are prediction markets that focus on predicting the outcomes of political events, such as elections and referendums.

Entertainment markets

Entertainment markets are prediction markets that focus on predicting the outcomes of entertainment events, such as sporting events, movie box offices, and award shows.

How do prediction markets work?

In a prediction market, participants trade contracts that represent different potential outcomes of an event. For example, on platforms like Polymarket and BET, you’ll discover contracts representing the outcome of a presidential election, a sports championship, or even the price of a cryptocurrency.Here’s a simplified breakdown of how these markets function.

1. Contract creation: The platform creates contracts for various events. Each contract represents a specific outcome. This can include outcomes like a political candidate winning or Bitcoin prices reaching $100,000 by a specific date.

2. Market opening: Once a contract is created, it opens for trading. Participants can choose to buy or sell these contracts. The price of a contract reflects the market’s perception of the likelihood of that outcome. If many people believe an outcome is more likely, the contract’s price will be higher.

3. Settlement: When the event occurs, the contract expires. The contract representing the correct outcome will be worth a predetermined amount, typically $1. Contracts representing incorrect outcomes become worthless.

How predictions on Polymarket work

Let’s now look at platform-specific examples to better understand how prediction markets work. On Polymarket, you might find a contract for the outcome of Ether’s year-end price and whether it’ll hit all-time highs (ATH). If you believe ETH prices will exceed its previous ATH of $4,891.70 in Q4, you can buy a contract representing that outcome for $0.14 worth of USDC stablecoin. If your prediction is correct, you’ll receive $1 when the market resolves itself at the end of the year. If ETH fails to break ATH, your contract will become worthless.

How predictions on BET work

As for predictions on BET, you’ll discover that contract collateral is supported by more than 30 different tokens. Collateral flexibility aside, there are similar contracts here that cover political and economic markets. One contract that’s gained attention in early 2024 is on the possibility of the U.S. Federal Reserve cutting interest rates by at least 50 basis points at the September 2024 Fed meeting. With ‘Yes’ odds breaching 24%, it’ll certainly be one to watch as we approach the September 18 resolution date.

In essence, prediction markets allow participants to speculate on future events and potentially make gains from their predictions. They provide a unique way to gauge public sentiment and can be used as a tool for risk management and decision-making.

Benefits of using prediction markets

• Hedging risk: Prediction markets can be used to hedge against potential losses in other holdings. For example, if you're concerned about a potential market crash, you could buy contracts that predict a market decline.

• Speculating: Prediction markets can also be used to speculate on future events. If you believe that a particular event is more likely to happen than the market currently predicts, you can buy contracts that represent that outcome.

• Learning about market sentiment: Prediction markets can provide valuable insights into market sentiment. The prices of contracts can reflect the collective wisdom of the crowd, which can be helpful for making informed trading decisions.

Risks of using prediction markets

• Price fluctuations due to market volatility: The prices of contracts in prediction markets can be highly volatile, fluctuating rapidly based on changing market sentiment and new information. While this volatility is to be expected in rapidly fluctuating markets like crypto, this can be an emotional roller coaster for beginners and risk-averse individuals.

• Market manipulation and outcome influence: While unlikely for geopolitical markets, individuals or groups may attempt to manipulate the prices of contracts to influence the outcome of an event, like the match-fixing we sometimes see in organized sporting events. This can give certain participants an unfair advantage and distort the accuracy of market predictions.

• Changing laws and legal uncertainty: The regulatory landscape for prediction markets is constantly evolving. Governments may introduce new regulations or restrictions that could impact the availability and operation of these platforms.

Key factors to consider when choosing a prediction market

When choosing a prediction market platform, there are several key factors to consider.

Reputation and reliability

It’s important to choose a platform that has a good reputation and is reliable. Look for platforms that have been in business for a while and have a positive track record. For example, prediction markets like Kalshi are regulated by the Commodity Futures Trading Commission, which gives them some form of staying power in the U.S..

Variety of markets

A good prediction market platform will offer a wide variety of markets to choose from. This diversity provides participants with more opportunities to hedge risk, speculate on different events, and diversify their portfolios according to the interests of a wider audience.

Fees and commissions

Prediction market platforms typically charge fees or commissions on trades. As these fees tend to add up over time and erode overall gains, it’s important to compare the fees charged by different platforms to find the one that offers the best value.

User interface and experience

The user interface of a prediction market platform should be easy to navigate and use. Look for a platform that has a clean and intuitive design.

How to sign up for and use prediction markets

If you’re interested in using prediction markets, here’s a brief overview of the steps involved.

Creating an account

To get started, you’ll need to create an account on a prediction market platform. This typically involves providing some basic information, such as your name, email address, and password. In some prediction markets like BET, you can opt to log in with your OKX Wallet instead.

Funding your account

Once you’ve created an account or connected your wallet, you’ll need to deposit collateral onto the prediction market platform. Most prediction market platforms allow you to deposit funds using a variety of cash and crypto options.

Placing a prediction

To place a prediction, you’ll need to select a market and choose a contract. You can then buy or sell the contract at the current market price with a market order or choose to enter at a specific price with a limit order.

Understanding payouts

If your prediction is correct, you’ll receive a payout, where your overall gains will depend on the price of the contract you originally paid and the price of the contract at time of resolution.

The future of prediction markets: will history repeat itself?

While newcomers may find Polymarket and BET innovative in growing the decentralized prediction market space, the truth is that prediction markets are nothing new. One noteworthy example would be Augur and how it rose and fell within the span of a few years.

As an idea that was introduced in 2014, Augur was one of the earliest decentralized prediction market platforms. With backing from Ethereum co-founder Vitalik Buterin, Augur looked prime for success as it sought to revolutionize the way we forecast future events. Like many other projects during the 2017 crypto boom, Augur gained significant traction as it attracted investors and traders who were eager to participate in the emerging market. However, Augur faced several challenges, including scalability issues, user experience limitations, and regulatory scrutiny while trying to gain mainstream adoption. As a result, its popularity waned over time, and the platform struggled to maintain its position as a leading player in the prediction market space.

Does Augur’s story paint a bleak future for prediction markets?

Fortunately, there’ve been many developments that have helped decentralized prediction markets overcome the initial roadblocks faced by pioneering prediction markets. This includes significant advancements in blockchain technology as transaction fees are little to none, user interfaces being refined to lower any possible barrier to entry, and greater regulatory clarity, as prediction markets are slowly getting the nod of approval from regulators.

These developments have made it easier for prediction market platforms to scale, provide a better user experience, and operate within a more favorable regulatory environment. As a result, newer decentralized prediction market platforms have been able to build upon the lessons learned from earlier projects and offer more robust and user-friendly experiences. While it’s impossible to predict the exact future of prediction markets, the ongoing advancements in the industry suggest there's significant potential for growth and innovation. As these platforms continue to evolve and mature, they may play an increasingly important role in shaping our understanding of future events and informing decision-making across various sectors.

Final words and next steps

Prediction markets offer an exciting opportunity to hedge risk and speculate on future events. However, it’s important to understand the risks involved before aggressively diving into prediction markets. By doing your research, considering the risk-to-reward ratios of each prediction, and choosing a reputable prediction market platform, you can increase your chances of success in prediction markets.

Curious about the other types of innovation in the crypto space? Learn about how Ethena is revolutionizing the perception of yield in the world of DeFi. Alternatively, you can read out about how Jupiter is aggregating liquidity on Solana.