What Are Prediction Markets?

Explanation of the concept of prediction markets and description of their working process, overview of their advantages and disadvantages, the way of cooperation between prediction markets and blockchain, the list of examples of prediction markets powered by blockchain.

Prediction markets have been in existence for decades, but with blockchain-related inventions leveraging the concept, a new level of excitement about prediction markets has been reached. Today the potential impact of prediction markets could go far beyond betting.

A prediction market is a collection of people speculating on the outcomes of events. A prediction market is an exchange where people trade contracts for future events. These events may include sales of a company, stock price fluctuations, elections, weather changes, or any other event where the result can be objectively verified. The main purposes of prediction markets are to aggregate public opinion and to estimate the probability of an event.

How do prediction markets work?

Prediction markets award users for correct predictions.

Let’s say, there is an election. A prediction market issues to types of contracts: A-contracts for Candidate A’s victory, and B-contracts for Candidate B’s. When the elections are over, the prediction market will pay users $1 for each winning contract they hold, while losing contracts will be worth nothing. Most users think that Candidate A will win, so they buy as many A-contracts as they can. The demand for A-contracts increases, and so does their price. If an A-contract trades at 78 cents, then we can say that Candidate A will win with the approximate probability of 78%. Respectively, a B-contract costs 22 cents, and Candidate B’s chances are 22%. You buy 10 A-contracts for $7.8, and if Candidate A does in fact win, you are paid $10 for your 10 contracts. Thus, you made a profit of $2.2.

What do they have to do with blockchain?

Prediction markets operate by the Wisdom of the crowd principle. This idea suggests that a group of people are right more often than any individual within that group. The group can give more correct answers than any of the group members. This is why prediction markets are a powerful prognosis tool.

Prediction markets have been around for decades. However, they all had one crucial flaw — the outcome of an event had to be verified by a person. The human factor implied that there could be mistakes, lies, manipulation, and corruption.

Blockchain revolutionized prediction markets such that they no longer need to rely on people to confirm events. Now prediction markets use oracles that automatically record real-world data onto blockchains for safe untamperable storage. Blockchains allow prediction markets operate in a completely decentralized unbiased way.

What are their flaws?

One problem with prediction markets that is still relevant is how they should be treated. Some governments see them option markets, others recognized them as betting markets. This creates a lot of confusion when it comes to regulation.

Prediction markets also pose a threat of controversial incentives, such as assassinations and terroristic attacks. For example, a market can predict a death of a political figure and, thus, creating an incentive for murder.

What are some examples?

Augur is an automated prediction market built on the Ethereum network. The platform has no fees and does not manage trading operations. Its developers cannot modify smart contracts or spend funds held in contracts. Behind Augur is a non-profit organization called The Forecast Foundation.

Gnosis is a prediction platform that aims to serve financial, insurance and information markets. They also want to aggregate data produced by artificial intelligence to provide highly accurate results.

Another example is Stox, a decentralized platform that aims to bring prediction markets to mainstream audiences.

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