Contents

  • Entrance

  • What is the prediction market?

  • Why are prediction markets useful?

  • Prediction markets and blockchain technology

    • Resistance to censorship

    • no intermediary

    • non-consensual

  • The power of blockchain oracles

  • latest ideas


Entrance

When you see the terms blockchain and market used in the same sentence, you undoubtedly think of the stock market ecosystem that provides the infrastructure for cryptocurrency trading. But in fact, blockchain technology can serve many different purposes, and many different types of markets can be built on top of it.

Financial assets can be either physical objects (tangible) or digital products (intangible). However, regardless of its type, if the asset has value, there is a potential market for this asset.

In this article, we will focus on one type of market that can significantly benefit from blockchain technology: prediction markets.


What is the prediction market?

A prediction market is a speculative market where participants trade information, not just options or cryptocurrencies. Investors in the prediction market bet on the outcomes of future events.

This can be any event you can think of (of course it has to be an event a broker would agree to list). Let's take an example of a question with a yes/no answer: Will there be a train from the US to Europe by 2025?

There are two possibilities here. Such a train either happens or it doesn't. If you are sure that the train will not be operational within the next five years, you can purchase a few charity contracts. Contract prices are between 0 USD and 1 USD.

If the train is not in operation by the specified deadline, no contracts can be redeemed at 1 USD and yes contracts have no value. Conversely, if the train is in operation, then no contracts have no value and yes contracts have a value of $1.

However, contract value fluctuates as market sentiment changes and new information emerges. For the example above, as the deadline approaches, the price of charity contracts may rise if there is no development for underwater tunnel technology. However, an announcement by a major company that it will operate this train service by 2024 could cause the price of yes contracts to increase.

Prediction markets may appear to be similar to standard speculative markets. Participants purchase contracts in the hope that prices will increase over time. But in fact, prediction markets are very different from the average speculative platform. When used correctly, they can become powerful predictive tools.


Why are prediction markets useful?

Before placing a bet, market participants are likely to have some information that influences their decision. Unlike standard gambling, there are external factors that will affect the likelihood of certain outcomes.

Smart investors do their research and experts offer their opinions. Those who are knowledgeable about the subject or have access to insider information invest in contracts that they believe will have a higher value. At their most essence, prediction markets serve as sources of information.

In our transcontinental train example, if no contracts are trading at $0.90 and yes contracts are trading at $0.10, this tells us that relatively fewer people believe in the success of the concept. The market's collective insight is reflected in the data, with those in the know economically incentivized to 'share' their knowledge.

Prediction markets are very good at aggregating and presenting information. It works on the principle that the wisdom of crowds will always prevail over data known only by a few experts. Stakeholders from all sectors, from IT to renewable energy, can gain an advantage by examining these markets because they can understand what is deemed more likely to happen by the ecosystem. Moreover, markets crowdsource information to achieve an accurate picture of future outcomes.

Advocates even believe that prediction markets could serve as the underlying technology in a new form of democracy known as futarchy.

We may not even need yes and no agreements. We can use any two non-intersecting results. One popular example of this is presidential elections. Let's assume the competitors are Candidate A and Candidate B. Bettors can purchase Candidate A contracts if they believe Candidate A will win, and can purchase Candidate B contracts if they believe otherwise.


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Prediction markets and blockchain technology

Prediction markets can be very powerful tools on their own, but if they are decentralized their value proposition can be greatly strengthened. Today, what central platforms offer is quite limited. This may be due to local regulations or because platform owners do not want to include certain agreements. Ultimately, users have to trust the administrators of such platforms and pay extra fees to benefit from the service.

The traditional centralized model can be replaced by decentralized alternatives with a blockchain-based approach. This can have many benefits, including censorship resistance, reduced number of intermediaries, and increased accessibility.


Resistance to censorship

Current prediction markets are typically run by a single party. This means that government officials or malicious actors can easily shut down these platforms. Decentralized platforms cannot be shut down so easily.

On platforms governed by smart contracts, this single point of failure is eliminated. The code is run by each node on the network. If contracts are created in a certain way, no user can change or delete the programs underlying the market.


no intermediary

Blockchains do not need administrators. The need for intermediaries is eliminated as work normally done by third parties is directed to an automated code. Users interact directly with the smart contract. This means that users will not pay transaction fees to a third party (unlike centralized platforms). Since the user does not have to trust anyone, counterparty risk is eliminated.


non-consensual

In decentralized prediction markets, individuals from all over the world can place bets or create contracts that users can access globally. Geographic and regulatory restrictions that blocked previous platforms are no longer a problem.


The power of blockchain oracles

If there is no intermediary and no central authority of any kind, how can we determine which outcome has occurred at maturity?

We need some kind of “reality” mechanism, and that’s where blockchain oracles come into play. We need to use a data source that will tell us with certainty whether an outcome has occurred or not. There are several useful possible approaches to this.

The simplest would be to connect to a third-party website or data stream, but this is fundamentally at odds with the use of blockchain because the control of the results is in the hands of the third party. For example, they may choose to lie for their own benefit or become a target for those who want to cheat.

The other option is to financially incentivize users to share the real results of events. Staking mechanisms may be used that require users to link their tokens in order to report. If they report accurately, they are entitled to some sort of reward. If they attempt to cheat, they lose the tokens (stake) they have tied up. This model is used by the first blockchain prediction market platform, Augur, to resolve disputes. Others, like Gnosis, allow users to choose between different centralized and decentralized solutions.

The use of blockchain oracles in prediction markets is a new concept. Since it is an immature technology, it is not yet clear which oracle structure is suitable for different types of prediction markets. A report on the subject was published by Binance Research last year. Notably, the report identified a Design Flaw Attack and other bugs in one of the most popular prediction market applications.


latest ideas

Prediction markets are interesting tools for betting on future outcomes, but they can also be sophisticated tools for gathering reliable information about almost anything. By financially incentivizing individuals to share their knowledge in the marketplace, we can gain insights into social, industry and political trends.

Currently, prediction markets cannot reveal their true potential due to the inadequacies of central platforms. However, this situation may change with decentralized alternatives. As more capable oracles are developed, blockchain technology could host provably correct code that cannot be tampered with.