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What are Prediction markets?
Prediction markets are also known as futures markets, event derivatives, information markets, predictive markets, idea futures, or virtual markets. They can simply be explained as trading markets that are constructed for the purpose of trading the results of a specific event. This event can be anything that gives the traders a binary option. This means that the outcome of the prediction will either give a specific outcome or absolutely nothing. They generally take on the concept of crowdsourcing to generate outcomes or beliefs on specific topics of interest such as election results, exchange averages, gross movie receipts, commodity prices, or sales returns which have an unknown future result.
Prediction markets have become extremely useful and accurate tools for generating the outcomes of specific events. Researchers argue that they are even better and accurate at forecasting future outcomes than advanced statistical tools because they heavily rely on knowledge gathered from a broad selection of users, who, place a bet on the potential likelihood of an event occurring using prices. These market prices which are basically different beliefs of different traders related to the unknown future outcome represent the collective belief of the market (users/traders).
History of Prediction Markets
Prediction markets have long been in use in the world. Early traces of prediction markets were first discovered in political betting. An example of an early political betting prediction market can be traced back to 1503 whereby participants would actively place a bet on who would be the papal successor. Even then, it seemed as if it was already an old custom that people participated in. Election betting is also not a new thing as there are old records that date back to 1884 in Wall Street that prove people participated in bets that would try to forecast election results.
Development of Present-Day Prediction Markets
- One of the first present-day prediction markets is the Iowa Electronic Markets created by the University of Iowa. It was first introduced in 1988 during the US presidential elections.
- In 1996, a virtual game known as the Hollywood Stock Exchange was introduced where participants could buy and sell shares based on predictions of films, actors, directors, etc. In 2006, it was particularly accurate in predicting 32 out of the 39 big Oscar nominees and 7 out of 8 top category winners.
- Robin Hanson used the first corporate modern prediction market in 1990 at Project Xanadu. Employees particularly used it to bet on events such as the Cold Fusion Controversy.
- In 1991, the Commodity Futures Trading Commission regulated HedgeStreet and designated it as a market that would enable internet traders to have the ability to speculate on economic times.
- com launched a prediction market in 2001 from Ireland that allowed trading of fiat money between participants on a variety of categories such as business events, current issues, financial times, etc. Unfortunately, Intrade ceased the trading platform in 2013.
- The US DOD publicized a Policy Market Analysis on their website in July 2003 that speculated that additional topics for markets would include terrorist attacks. This, of course, did not go well as Pentagon canceled the program in haste.
- Journal Nature, a monthly scientific journal, stated in 2005 that major pharmaceutical company Eli Lilly and Company was using prediction markets to aid in forecasting which development drugs had a better chance of advancing through clinical trials by using internal prediction markets to forecast the outcomes of research and development events.
- The same year (2005), Google announced that it was making use of prediction markets to come up with a prognosis of product launch dates, new openings of offices, and other strategic issues. HP and Microsoft also make use of prediction markets for forecasts.
- In October 2007, several companies from Austria, Germany, Ireland, Denmark and the US formed the Prediction Market Industry Association. The PMIA was tasked with activities such as promoting and creating awareness, education, and validation for prediction markets. The association no longer exists or functions anymore.
How Do Prediction Markets work?
As stated earlier, prediction markets are created for the specific purpose of trading the future outcomes of an event. The market prices of the prediction market are usually determined by the market forces of demand and supply. This means that the prices in a prediction market usually fluctuate depending on the opinions of traders regarding the outcome of the event. They keep shifting until they finally come to a balance. For example in the case of an election, one trader may believe that a certain candidate X may win an election based on their individual experiences, education, beliefs, or even analysis. Another trader may believe that the candidate will not win the election and that another candidate, say Y, will win the election.
The outcome of the above event is binary; either candidate X will win the election or lose. The same applies to candidate Y. There are no other outcomes to the specific event. However, these are the beliefs of two individuals, which creates a perfect balance in the probability of the event happening. Meaning, depending on their beliefs, the probability of each event happening is 0.5. However, as more and more traders give their input, the ratio starts to change and fluctuate as it tries to find balance. Eventually, the market prices will find a balance and will give a clear outcome of who the traders believe is going to win the election.
Traders, therefore, win a trade, if the particular event holds true. For example, if candidate X wins the election, all the traders who had predicted that outcome, win the election and receive whatever pay the market has structured. Those who had predicted that candidate Y would win the election end up getting nothing. That’s how prediction markets work. The incentive of prediction markets is that people are putting down real money based on the eventual outcome and thus, you need to be an expert or at least have enough experience to be able to come out with a possible win to the situation.
There are essentially different ways of managing prediction markets. The first way is giving traders the permission to buy and sell contracts that will eventually payout based on the outcomes of events. The eventual price is determined by the buying and selling orders. This is where the market depends on the forces of demand and supply to get the eventual market price. The other approach is for a market administrator to initialize a price which he can adjust once traders start making predictions. The traders are eventually rewarded based on the accuracy of their predictions.
Blockchain and Prediction Markets
The Commodities Futures Trading Commission (CFTC), has clearly stated that it does not support any group or company that facilitates individuals to buy and sell product options even if they are prediction contracts, especially if they are not registered with CFTC. They termed the whole activity as unlawful and illegal. Such was the fate of Intrade once CFTC caught up with them. They shut down their operations and have remained defunct throughout the whole time period.
However, now, there is hope for prediction markets through the use of blockchain technology. Blockchain engages prediction markets in that it provides them with an open and decentralized platform that is free from central authority or control and cannot be manipulated or changed. It offers prediction markets freedom from historical jurisdictional regulation. Also, unlike Intrade, once a prediction market goes live on the blockchain, it cannot be shut-down at all. This will remove the risks of shutting down by central authorities and at the same time, the risks associated with middle-men or any third parties who may intentionally withhold relevant information to keep themselves ahead. It subsequently lowers fees and fosters trust among traders as all information is publicly displayed on the platform for everyone.
Blockchain-based prediction Markets
The blockchain has caused a massive shift in the financial sector and has single-handily managed to challenge and break traditional norms that once seemed unbreakable. Other than providing cryptocurrencies and digital currency trading platforms, blockchain has also enabled the growth of crypto prediction markets that are already creating a buzz in the industry. Some of the well-known blockchain prediction markets in existence today include:
Below is a more detailed look on each of the above ICOs related to the prediction market.
Stox is an open source prediction market that runs on the Ethereum blockchain platform. It was originally built by a group of financial veterans based on experience and knowledge gathered from Investing.com who have been operational since 2014. Powering up Stox is the platform’s token, STX, which is the main currency for wagers in event forecasting and the main form of fees and collateral.
Stox engages the prediction market platform by allowing traders to actively trade the results of any event in any imaginable category such as sports, weather patterns, election results, celebrity marriages, etc. Stox intends to capture the mainstream investors by providing a safe haven away from traditional financial key players such as the governments, organizations, or firms. It allows them to participate in prediction events with the incentive of making a profit while at the same time using their knowledge to the maximum in any imaginable field.
The following are some of the ways that Stox is creating a different kind of prediction market. They include:
- Stox views the prediction market as a business whereby investors or traders who have or possess a greater degree of information which is of greater quality and can help in making better-informed choices, are capable of exchanging this knowledge for financial gain through the use of STX token in event results.
- The STX token grants providers on the system the ability to offer exchange services from fiat currency to STX token and vice versa without the need of becoming a general use exchange.
- Stox makes use of the Oracle mechanism.
- Stox enables several providers on the platform to be able to cooperate and act as part of a larger network. This, in turn, enables users to enjoy a well-rounded selection of categories that accommodate their interests thus, creating overall engagement.
Gnosis is also a newer blockchain-based prediction market that has been in development and operation since 2015. It was founded by Martin Koppelmann and Stefan George. Being a decentralized prediction market, Gnosis operates on the blockchain Ethereum platform. It will make use of the GNO token that is fixed to reach a total supply of 10 million. The developers of Gnosis recognize the fact that nowadays, information is everywhere. However, not all information is true, and most of it lacks context and objectivity. Also, most of the written information usually carries individual biases, and in some cases, it is intentionally manipulated to misinform. Gnosis intends to engage and revolutionize prediction markets in the following manner:
- It intends for the platform to be used and accessed by everyone. Gnosis is an open platform that will provide unbiased and transparent access to all individuals everywhere and anywhere and at the same time, providing the same liquidity and market price to everyone in the market.
- Gnosis will remove the traditional norm of using a panel or a group of predestined experts to carry out research or dish out information about future events. It will allow for a more efficient and informed market whereby individuals with information can be allowed to participate.
- By providing an open and decentralized platform that is permissionless and trust less, Gnosis creates an incentive for individuals who feel that they have relevant information to come forward and trade while at the same time forcing individuals without information to go gather it to participate in market trading in order to acquire profits too.
- It will also enable any participant or user to ask a question and fund the search for an answer. Ideally, it will create a decentralized custom Google of some sort whereby information is aggregated from different participants with different levels of information, therefore, creating the globe’s finest and efficient forecasting tool.
The following are some of the uses of Gnosis. They include:
- Information Gathering.
Companies, firms, individuals, and even governments will be able to collect information easily and cheaply as previously. For example, a piece of art may be set within the platform, and the price of the art determined way before the art is auctioned.
- Decision Making
Decisions can now be easily made through the use of prediction markets. For example, an important question about budget allocation can be posed and which sector should receive a higher amount of budget allocation will be made unanimously unlike before when only a few select ‘experts’ were tasked with making the decision.
The potential uses of Gnosis are any and will continue to grow as the platform grows and becomes saturated with more and more traders. At the moment, a test version of Gnosis, Gnosis Olympia, is in use and is being tested to find out whether the market is ready for a decentralized prediction market.
BlitzPredict is another blockchain-based prediction market, however, still in its development phase. It intends to provide a worldwide platform that utilizes fintech solutions to provide liquidity and function to users of sportsbooks and blockchain prediction markets. BlitzPredict will make use of 3 tools namely:
It will ensure that all users of BlitzPredict get access to an updated sports book or prediction market whereby all the best odds currently available in the market will be posted.
BlitzPredict Liquidity Reserve
It will ensure that users can get paid immediately an event comes to an end thereby reducing the time delays experienced by other prediction markets.
BlitzPredict Smart Contracts
This tool will give the users seamless access throughout the prediction market thus ensuring that users get maximum efficiency from the markets.
The main token that will be used on the platform will be the XBP token. BlitzPredict users will earn rewards anytime they stalk up their XBP tokens to support the liquidity reserve of BlitzPredict. BlitzPredict will also initialize a BlitzPay activation on every XBP token that will allow the users to liquidate their tokens instantly. Also, it will make use of Bancor Token Relay that will enable the users to instantly buy or exchange their XBP tokens for any other token within the Bancor Network. The tokens will also have smart contract functionality automatically enabled that will entitle the users the access to instant payouts once certain pre-set requirements are met.
BlitzPredict can be used as a tool for the analytics community. For instance, there are so many sportsbooks and betting syndicates that make use of their own analytics tools thus creating different predictions in the market. Also, this different institutions will tend not to share their predictions with each other. This leads to the prediction market having fragmented approaches towards the future outcome of an event. This creates inefficiency in the same market as most of the institutions are working individually towards solving the same problem.
BlitzPredict as a platform tends to solve this problem by ushering in a new system of blockchain predictive analysis that will allow experts in the analytics industry to have an incentive to share their information whereby users will have to spend XBP tokens to be able to access the information. Also, those experts who have quality predictions will be rewarded, and in this manner, all inferior or misguided information will be slowly eradicated.
Augur is a prediction market platform that is trustless and decentralized. Augur, will depend on the blockchain platform to drive the fees of participating in a prediction market will be as low as the market can allow. It will make use of smart contracts and an oracle that allows real-world situations to be migrated onto the blockchain platform without the need of an intermediary.
Augur’s prediction market will make use of 4 stage progression. This 4 stage progression will consist of:
The market will help anyone to create a mart on the platform based on an upcoming real-world event. The market creator will also set the event end time and also choose a smart researcher for the market.
After the successful creation of the market, market participants will then forecast or predict the outcome of the event. Traders will need to make use of market shares to be able to trade on the platform. Traders will make use of REP tokens to be able to participate in the market.
Once the event has taken place, the final outcome must be determined so that the market can finalize and start the settlement process. The Augur outcomes will be determined by the oracle which consists of market reporters who will delineate the real event outcome in the real world. Those who will have provided accurate results will be rewarded while those who gave incorrect predictions will be financially penalized.
This will take place in two ways. The trader may choose to settle his or her shares with the market. The trader can also decide to sell his or her shares with another trader in the same market.
Are Prediction Markets the Future of Trading?
Prediction markets have proven themselves as such useful tools of prediction and information aggregation that even big companies such as Microsoft have taken advantage of their predicting capabilities. Some have actually named them as better forecasting tools than any computer analytical and statistical tools. They can also be used to anticipate crash predictions of the stock market if they are put to good use. A lot of individuals in the crypto-community believe that these prediction markets will be the future of information sharing based on the wisdom of the crowd.
Unlike the stock or forex market that heavily depends on trading signals, trading charts, and trading indicators to enable traders to make decisions, the prediction market will rely on the wisdom of the crowd. The wisdom of the crowd is a term that is used to denote the fact that a larger number of individuals is capable of making better and informed decisions compared to an individual. The underlying principle behind the theory of wisdom of the crowd is the fact that a group of individuals have different experiences and knowledge of events and thus, can accurately predict the future outcome of an event. The fact that some organizations are using internal prediction markets to make decisions and share information is already a strong indicator that their potential use in the future is imminent.
What are the Risks of Prediction Markets?
Decentralized prediction markets are open to the threat of price volatility especially due to the fact that they make use of cryptocurrencies to facilitate trading on their platforms. The prices of cryptocurrencies have proved to be volatile and tend to change in short durations of time.
Manipulation of the market by a market creator
Suppose that a participant poses a question regarding the future outcome of an event. If he or she is directly tied the event in question and can control the outcome of the event, then he or she will most likely manipulate the final outcome so that it may favor them depending on how the market responds.
Are Prediction Markets Legal?
It may seem that prediction markets are a hefty mess to launch when it comes to complying with the law. Intrade, for instance, got shut down when the CFTC came knocking on their doors. Also, some of the above prediction markets have stated that they actively plan to comply with the laws of their region of operation. The CFTC notes that it does not allow the operation of prediction markets unless they are properly registered under them. This means that they get to monitor the markets themselves. Beats the essence of decentralized prediction market if it cannot operate without the control of a central authority.
Is Prediction Markets Betting?
Prediction markets function differently than betting markets. The functionality of the prediction market can be compared to that of a coin flip. The results of a coin flip will always be 50% heads or 50% tails. There are no in-between outcomes. The betting market, on the other hand, has various outcomes to an event. For example, a common betting technique used in football sports betting usually asks the placer of the bet to choose whether a certain team will win, lose, or draw in a match against another team. This gives each outcome a 33.33% chance of happening. Prediction markets on the hand are binary, either an event takes place, or it doesn’t at all. Prediction markets also rely on the concept of wisdom of the crowd which is not open to external influences or control. Therefore, prediction markets are not a form of betting.
Are Prediction Markets Safe?
Prediction markets are safe. So far, there have not been any life-threatening events that have termed them as scams or Ponzi schemes. In fact, most research reveals that they are important to the information aggregation and sharing aspect as well as predicting the outcomes of future events with acute accuracy. So far, predictive markets are used for both pure speculation purposes and entertainment or by large organizations to make better and informed decisions. They are, therefore, safe.
In a Nutshell
Prediction markets are perfectly safe and legal tools for use in forecasting certain events. Their legality, however, relies on their region of operation and the subsequent laws that govern prediction markets operations. There is a high possibility that prediction markets are going to be the future of trading. Unlike before, the timely invention of the blockchain has created such an impressive platform whereby prediction markets can operate freely without the influence or control of a central authority. They will also be available to everyone, thereby, increasing the prediction capabilities of the participants.
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