Author: Revc, Golden Finance

Preface

The prediction market continues to gain momentum, with trading volumes hitting new highs. In the last week of September, Polymarket and Azuro had a trading volume of $570 million. The market is showing great potential for development, with innovative products emerging one after another.

In the short term, the US election has played a key role in the development of the prediction market. Including the congressional election, the total expenditure of this election may reach nearly 16 billion US dollars, which is the most watched event by the American people. However, the market is generally not optimistic about the performance of the prediction market after the election.

PolyMarket

According to Dune, Polymarket’s total trading volume has exceeded $4.1 billion, with users generating nearly 5.2 million trades in total.

However, the overall profit level of users is not optimistic. According to the data of the on-chain analysis tool Layerhub, 149,383 (87.3%) of the 171,113 crypto wallet addresses on Polymarket are not profitable. There are 21,730 wallets that have been confirmed to be profitable, accounting for 12.7% of all participating crypto wallets. Among the wallets that reported profits, only 2,138 users made profits of more than $1,000, and most of the profits were between $0-100.

That could change as the biggest predictions settle, with bets on the 2024 presidential election now exceeding $720 million.

Let’s review the design mechanism of Polymarket:

1. Polymarket converts binary outcomes on the Polygon network into ERC1155 tokens. This allows collateral to be split into outcome tokens and re-merged after the outcome of the event is revealed (i.e. the probability becomes 0 or 1).

2. Polymarket uses a hybrid decentralized order book model, also known as the Central Limit Order Book (CLOB). Operators provide off-chain matching and sorting services, but the actual settlement and execution of transactions are performed on-chain in a non-custodial manner. In addition, users can also choose to trade through an automated market maker (AMM).

3. Polemarket resolves market disputes through UMA's optimistic oracle. If there is a dispute over the outcome of an event, UMA token holders will vote to determine the correct outcome.

Polymarket collects a 2% fee from winning bets to reward liquidity providers. So far, Polymarket has paid more than $3 million in USDC rewards to liquidity providers to enhance market liquidity.

However, since the transaction price (probability) of the predicted event will approach 0 or 1, which is different from the price change logic of traditional assets, liquidity providers face a higher risk of impermanent loss. Therefore, a more complete reward mechanism is needed to cover the liquidity providers' capital costs and impermanent losses.

What are high-quality forecast events?

Polymarket's success has benefited from the US election. Currently, the top predicted events in terms of trading volume are all related to the election, and the product explosion overlaps with the election cycle. Under the background of strong regulation in the United States, people's trading needs are released in Polymarket.

High-quality forecast events are the core of the forecast market's competitiveness, which usually requires the following factors:

1. The social media influence of people involved in the incident, such as Musk’s halo as CEO X and the world’s richest man, helped Trump’s election.

2. Huge social heat. As mentioned above, the two parties spent nearly 16 billion U.S. dollars on campaign funds in the election year.

3. Prediction events with relatively balanced probabilities, equal potential of relevant parties, multiple game-influencing factors, and a limited set of choices. This can attract sufficient liquidity aggregation, reduce users’ initial losses (information asymmetry losses) and liquidity providers’ impermanent losses.

4. Contrary to the third point, the prediction events are superimposed and mixed to increase the randomness of the results and the entropy of the whole process, catering to the needs of users with higher risk preferences.

Predict new development trends of the track

The prediction market is currently innovating mainly in the areas of liquidity and user participation, but the innovation is limited, and future competition will mainly take place at the event operation level. Micro-innovation is mainly reflected in the following aspects:

1. Through the peer-to-pool liquidity model, funds are concentrated to meet market demand, ensuring that even niche markets have sufficient liquidity. However, the liquidity of the prediction market itself has the characteristics of random freedom according to the degree of information dispersion. If excessive attention is paid to liquidity and its costs cannot be reasonably covered, it will affect the development of the prediction market in the long run. Aggregating liquidity means a certain degree of market distortion.

2. Allow users to make more complex leveraged bets to increase market attractiveness, but pay attention to risk management.

3. Use social media for promotion, integrate specific scenarios, and increase user engagement.

In addition, AI’s potential in event selection, information aggregation and analysis, and automated trading is also worth exploring. The process of pricing information is essentially about information dissemination, predicting the main line of market development, and making information dissemination more efficient and maximizing economic benefits.

Regulatory impact

The CFTC (Commodity Futures Trading Commission) stipulates that any contract involving illegal or contrary to public interest activities is not allowed. In 2024, the CFTC introduced a new rule prohibiting the trading of contracts on the results of political events, considering it to be contrary to the public interest. This has affected platforms that rely on political prediction markets such as Polymarket, PredictIt, and Kalshi. Elizabeth Warren even publicly asked the CFTC to completely ban these election prediction markets, fearing that they would interfere with the democratic process. With increasingly stringent regulations, platforms urgently need to adapt to the new environment, otherwise their business development will be restricted.

Prediction markets are reshaping the boundaries between politics and business, providing new possibilities for social decision-making. Although it currently provides economic freedom, its social and political influence has been eroded. The key to the problem is not the prediction behavior itself, but the regulators’ lack of adaptation to the emerging technology business model. Prediction markets that can leverage regulatory space and innovate business models will have better development.

summary

According to data from Layerhub, Polymarket currently has nearly 180,000 unique users. Although it has not yet had a significant impact on the overall user scale of the encryption market, as an economically reasonable Web3 product with excellent user experience, it has built a complete set of encryption solutions. The trading solution is worth learning from the industry.

As the US election cycle comes to an end, the prediction market still faces many challenges. In the short term, its role in decision-making and collective wisdom has not yet emerged, and problems such as insufficient market demand and liquidity need to be addressed. In addition, the constant changes in regulatory policies have also brought uncertainty to the development of the prediction market.

The prediction market has a positive significance in improving the transparency of social information, especially in the context of the declining credibility of traditional information channels. Its success story also provides inspiration for other Web3 projects: focus on segmented scenarios for mid-term sustainable development to meet a wider range of user needs.