Prediction markets have been around for quite a while now. They have also proven their usefulness over the years. Now, when you read about prediction markets and you have that with the word blockchain in the same paragraph or sentence, one of the first things that will come up eventually is cryptocurrency trading.
The versatility of blockchain technology has helped move prediction markets forward. Remember that today’s modern blockchain allows developers to build systems on top of the blockchain system—just like having an operating system in a computer where you can run other programs and applications on top of it.
In the world of prediction markets, a financial asset can either be digital or physical. Digital products of course are intangible while physical objects are tangible assets. It doesn’t matter if an asset is tangible or intangible.
What is important is that these assets hold value no matter what form they take. And if an asset has a certain value then there is a good chance that there is a market for it. Blockchain is so versatile that it can accommodate the trade of any asset regardless of its form.
What is a Prediction Market?
A prediction market is one where trade participants speculate on certain assets. They don’t necessarily have to trade cryptocurrencies or options. What they are actually dealing with is information.
In essence, what investors in these markets do is place bets on future events and possible outcomes. To help you understand the concept of prediction markets, let’s look at a very simple example.
Let’s say that there is speculation among investors whether or not a train company will still be running trains from Italy to France by the year 2030. Obviously, there are only two sides that you can choose from—yes, it will still be operating that line or no, it won’t.
If, according to your research, you feel confident that the company will still be operating that line on the aforementioned year, you can purchase any number of yes contracts. These contracts may be worth $1 or maybe $2.
If instead you believe that the opposite will be true by the said deadline, then you can purchase no contracts instead.
If in case the company still runs that line until 2030 then the yes contracts can be redeemed for $1 or $2 each. If not, then the no contracts will be valued at $1 or $2 and the yes contracts will lose value.
Note that as the years roll by the value of these contracts will fluctuate. Market sentiment will also swing up or down which will also affect the price of these contracts. Developments in the company will also drive the prices of these contracts as well.
If for instance, the train company finds itself in financial trouble after three years, then the no contracts will increase in price. But if the train company increases its operations in their Italy to France line then that will signal an increase in the prices of yes contracts.
You will never know the final prices of these contracts until the year 2030. That company events of that year will finally be the deciding factor for the value or price of these contracts.
At first glance, prediction markets will seem like another speculative platform. However, they are actually more than that since they can be used as forecasting instruments.
The Wisdom of the Crowd
The biggest benefit that investors can get from prediction markets is that they aggregate the wisdom of the crowd. It’s not gambling per se. You can expect investors to do their research on a given asset. There will also be market experts who will also pitch in.
The current prices of the contracts will also reveal the viability of certain possibilities for the assets in question. Going back to our example, if more people are buying yes contracts then it tells us that current research is indicating a more positive market for the company in the said transport line. If not, then there may not be a viable market for the company and they may end up losing money if they pursue that enterprise any further.
Prediction markets allow you to leverage on the expertise and knowledge of others outside of your organization. As such they are very good at amassing related information. It operates on the premise that the wisdom of the crowd that is based on data and information will be superior to any form of expert opinion from a few select experts.
Think of it this way—if two heads are better than one, what about having a lot of heads? How will collective wisdom impact your decision?
In this setup, researchers are also incentivized so they are more likely to report whatever expert opinion they may have. The next question is how blockchain technology can step into this picture?
The Impact of Blockchain Technology on Prediction Markets
It is true that prediction markets are very powerful tools. However, like any system present in our day, they too have downsides. And this is where blockchain technology comes in to the rescue as it were.
Prediction markets traditionally have centralized setups. Because of this the value proposition that they offer will have certain limits. Examples of such limits are reluctance of asset owners to list certain contracts and local regulations.
On top of that, interested parties are also required to pay premiums to platform owners (i.e. those who operate prediction markets). There may also be additional fees for using certain services.
Blockchain technology, which is decentralized, offers a non-conventional approach. It can provide increased accessibility, reducing the number of intermediaries, and censorship resistance.
We have already described how blockchain technology eliminates middlemen and other types of intermediaries along with other related benefits. Since blockchains are accessible globally, this new system eliminates regulatory and geographic restrictions, which are classic problems for prediction markets. Blockchains are censorship resistant since the records they contain is open to the public. Since the record is read only, not even government authorities can maliciously edit the records and they can’t be taken down as easily as websites and other forms of web properties.
Blockchain Oracles
One implementation method of blockchain technology in prediction markets is through blockchain oracles. These oracles serve as a truth determining mechanism that will replace the third party central authority.
Blockchain oracles will draw on the source data and it will determine whether an affirmative or negative outcome has been reached by the contracts at the deadline that was set for certain assets.
In the example that we had earlier, by the year 2030, a blockchain oracle can test whether the train company has maintained the train line in question or not. So, where will the data come from if there is no third party intermediary that experts can consult with?
One method to ensure the influx of data is to incentivize users of the prediction markets to report their data and information truthfully. Staking mechanisms can be implemented that provide tokens to users who report their data.
When users (e.g. those with insider information and industry experts) provide statements, summaries, and information that is backed up by actual data then they are given incentives such as digital value tokens.
Should there be any attempt to cheat on the part of the users, then they will forfeit their stakes. This incentive method is the one used by no limit betting exchange called Augur. It is a decentralized platform for prediction markets that is built on the ethereum blockchain.
The data that has been provided can be disputed and if it is found out that false information has been provided then the stake (e.g. tokens) is forfeited. There are other decentralized prediction market platforms as well and they have different models too.
For example, Gnosis also facilitates blockchain based platforms but they also allow users to use systems that may be partly centralized or perhaps centralized to a certain degree. This setup gives those who are interested in prediction markets more options to choose from.
Note that the use of blockchain technology in prediction markets is still in its early stages, which is why there are those who still prefer to use centralized systems. There are still flaws on how to implement blockchains for this type of market. However, the benefits that this technology can provide are very attractive—research is still underway and we can expect new implementations to come along in the future.
The bottom line here is that blockchain technology has the potential to improve prediction markets insomuch that their true potential can be realized.
