What Are Prediction Markets
A prediction market is a collection of people speculating on the occurrence of events in the future. Some of these events include: election results, commodity prices, sporting events, and more. Through the use of the “wisdom of the crowd” these markets determine the probability of a future outcome. Those who forecast the outcome correctly win money, and those who don’t lose.
Prediction Market Use Cases (why these markets are necessary)
Prediction markets have multiple use cases. The first is forecasting future events.Prediction markets have been used to “accurately forecast the outcome of political contests, sporting events and, occasionally, economic outcomes.”
These markets are able to produce accurate and reliable forecasts by efficiently aggregating a large amount of information, data and beliefs, and by financially incentivize info that is superior (more truthful) than others.
Another use case is hedging. Many individuals can use hedging as a way to protect themselves from undesirable and/or disadvantageous situations/events. For example, a farmer relying on a prediction market predicting there is going to be excess heat this year can use such info to limit any potential downside (e.g.: by limited growing certain crops that don’t fare well in the heat).
Other use cases include dynamic betting, making money and aggregating info without polls or expert opinions. Prediction markets allow dynamic betting by allowing participants to purchase or sell predictions up until an occurrence of an event; participants are free to change their predictions/bets if they wish. These markets can also be used for gambling purposes.
Current Issues With Centralized Entities
Prediction markets, until relatively recently, were all centralized. Centralization presents many risks and limitations such as: not allowing global participation, limiting what types of markets can be created or traded, and requiring traders to trust the market operator to not steal funds and to resolve the market correctly. Further issues with centralized entities are high fees (charging fees from 3%-10% of profit), inconsistent regulation from place to place and limited betting options (can’t change position once bet is placed).
These so called prediction markets (gambling industry in general) are a massive market, with overall figures varying from $459 billion to $3 trillion.
Benefits of Decentralized Prediction Market Platforms
Decentralized prediction market platforms aim to resolve some of the issues presented by centralized entities. These peer-to-peer driven networks eliminate the risk of corruption or manipulation as there is no central entity present. Having no central entity also allows global participation in these markets, which allows for more accurate markets, as there will be a wider variety of opinions from users. Other benefits include censorship-resistance and healthy competition among market creators that could result in lower market creator fees.
Examples of Decentralized Prediction Market Platforms (Top 3 platforms)
Augur is the most well known decentralized prediction market platform. Built on Ethereum, the Augur platform allows anyone to create a market for any event, so long as the outcome of that event can be verified in some way. Augur’s mainnet has been live since July 2018.
Augur markets advance through 4 stages: (1) Creation, (2) Trading, (3) Reporting, and (4) Settlement.
- Creation: Augur allows anyone to create a market based on any (upcoming) real world-event.
- Trading: Market participants forecast the outcomes of events by trading shares of those markets outcomes. Each possible valid outcome of the event is a tradable share (there can be multiple possible outcomes of an event). Shares can be traded at any time.
- Reporting: Outcomes are finalized by Augur’s oracle. These oracles are profit-motivated reporters who report the actual/real world outcome of the event. Reporters who have consistent reports with consensus are financially awarded, while those which are not consistent are financially penalized.
- Market Settlement: Two ways for a trader to close their position: (1) by selling their shares to another trader in exchange for currency, (2) by settling their shares with the market. The second settlement method only is possible when a market is finalized.
Augur also has a native token, Reputation (REP), which has a few roles on the platform. First, REP is needed by both market creators and reporters. Reporters, in order to report an outcome, must stake their REP tokens on one of the market’s possible outcomes. Market creators, on the other hand, when creating a market, set a creator fee, which is paid out to them by traders who settle with the market contract. Second, token holders can dispute the market’s tentative outcome with REP.
The platform also incentives active participation by holders of REP. If an individual holds REP but does not use his/her REP to stake on disputes or forks then they are penalized. All REP token hodlers need to be active on the platform in order to avoid losing some of their holdings.
Stox is also a prediction market platform being built on Ethereum. Its native token STX is the only currency used on the platform. Stox is similar to Augur in a lot of ways. Individuals can buy and sell outcome shares in a similar fashion and prediction markets can be created by anyone.
One big difference with Stox is that they integrated the Bancor protocol to help with liquidity problems. Bancor allows users to convert between different ERC-20 tokens without the use of an exchange. Bancor holds reserves of its native token to ensure that trades for STX can always be filled. While the Stox mainnet is live, there is not much activity currently going on the platform, and the websites roadmap stops at Q4 2018.
Gnosis is also a prediction market platform being built on Ethereum. The platform allows anyone to create a market and solicit forecasts for that market. It works in a similar fashion to the above two projects. One difference with Gnosis is that the project is creating an entire infrastructure layer that developers can use to build their own prediction market app. While an ambitious project, it is still to be seen if Gnosis will be successful in the long run. In addition, there roadmap stops short at Q4 of 2018 as well.
Challenges, Concerns and Miscellaneous
One major issue with these new decentralized markets involves regulatory concerns. While projects like Augur claim that the users are creating the markets, and not the team who created the platform, there are still regulatory concerns as many see Augur as another gambling platform.
Another major issues with these platforms are the high fees. On the Augur platform, for instance, total fees can range from about 3% to 9% and possibly more. These fees include fees market creators collect, ethereum gas fees and fees converting fiat to crypto in order to use the platform.
Some of these projects are built on the Ethereum network as well, which is still a nascent and experimental project and so scaling is still an issue. Other concerns include poor/not user friendly UI/UX interfaces, low liquidity on many markets (i.e.: low probability of an order getting filled), volatility in the crypto space as betting on these platforms is primarily done with cryptocurrencies, having to convert across multiple currencies just to participate, and competition from centralized platforms, even if the fees are higher.
Many of these platforms only recently launched their mainnet and so current usage on them is rather low. On Augur for example, during all of 2019 the amount of money at stake in all the markets was never above 1.5 million, and the overall volume has been declining since June. These concerns though can be possibility attributed to the long bear market in the space and/or how new/relatively unknown Augur is to many outside the crypto space.
Other interesting factors to consider regarding Augur’s long term viability is the growing amount of tools being built around the platform. Some of these tools include:
- Analytics by Curious Giraffe, which provides many relevant data trends,
- Predictions Global, which lists all of Augur’s markets and lets you look at the markets and their details categorically, and
- Veil: a financial derivatives trading platform built on Augur.
These are just a few examples, as there are many more tools being built around Augur. Tools for the other platforms are still very limited.
Of the three platforms outlined above, Augur has the most activity in general. Augur has more github commits (33,241) than either Gnosis (450) and Stox (72). It also has more Github contributor (75) than Gnosis (11) and Stox (1). There are more open markets and liquid markets on the Augur platform, and by a wide margin, than the other two combined as well.
Current prediction markets are flawed in a variety of ways, such as by requiring participants to trust in a third party to settle the market(s).Decentralized prediction market platforms are trying to eliminate the many risks posed by centralized entities.
While these projects are innovative and ambitious, there are still many concerns going forward such as possible congestion on the Ethereum Network, unfriendly user interfaces, and low liquidity. Legal concerns and volatility in the space are always looming concerns as well.
With the barrier for entering the crypto space still rather steep, and many not knowing of the world of decentralized apps, the long term outlook on these projects at this point is questionable.