How Crypto Transforms Prediction Markets

Prediction markets are speculative platforms where traders can place bets on the outcome of future events, such as “Will Joe Biden win the 2024 presidential election?”. If their bet was correct traders earn money but if they are wrong they lose the wagered amount.

Users obviously want to make money from these markets, which include PredictIt and Iowa Electronic Market. But the reason the type of prediction market has drawn so much academic interest is that they have a solid track record of making correct predictions, sometimes even predicting the future.

Some believe crypto assets can play a role in improving these markets. Right now the markets are highly regulated in the US, and participating in them costs relatively high fees.

Advocates argue that cryptocurrencies can dodge these issues. That’s because with cryptocurrencies users don’t have to place trust in a central entity. With Ethereum, the idea is the rules embedded in its code can guide certain actions in the project.

To test out this lofty hypothesis, a few prediction markets, including Augur and Omen, are now deployed on Ethereum.

Prediction markets FAQs

How do cryptocurrencies improve prediction markets?

There are a number of key reasons why advocates think cryptocurrency helps prediction markets:

Open: Cryptocurrencies have no boundaries. Users from around the world can purchase ether and other cryptocurrencies powering the prediction markets. Once users buy cryptocurrency they can send it anywhere around the world. Usually, prediction markets are restricted to use in the countries in which they were created. With cryptocurrencies, restricting this isn’t as feasible.
Less restrictive: Many of today’s most popular prediction markets pile on restrictions. If a user is winning in a lot of markets, for instance, they aren’t allowed to bet anymore. Cryptocurrency prediction markets strip away such restrictions, Augur’s website argues.
Lower fees (sometimes): Fees on centralized markets are higher than Ethereum fees most of the time. But this isn’t always the case. Ether fees have been swelling recently as the network has grown more popular and, as such, congested.
Can’t be closed down: Central prediction markets have been shut down before. Most famously, Intrade stopped serving customers in the U.S. to comply with U.S. law, leading to the demise of the platform. One goal of adding cryptocurrencies to the mix is users can make markets that governments can’t shutter.

That said, experts argue there are other reasons these types of markets haven’t gained more traction so far, including the fact they can be easily rigged. For example, someone could bet that Apple will announce the release of its latest iPhone during a certain time and possess insider knowledge about the event.

How do they work using crypto?

They use smart contracts, a type of innovative computer program that can execute actions automatically without needing an intermediary in the middle to help. In the case of prediction markets, smart contracts receive the money sent in by bettors, then automatically distribute it out to the winners when each market concludes.

In other words, users don’t have to trust decentralized prediction markets with their funds. The smart contracts will execute automatically. The flip side of this, though, is that users have to trust smart contracts, which are still a relatively new technology. Many smart contracts have contained bugs or flawed code leading to loss of funds in the past.

Now, how do smart contracts know who guessed correctly? So-called oracles are data services that feed real-world data to smart contracts. Say a prediction market asks, “Will the temperature be below 30 degrees tomorrow in New York City?” We might use weather.com as an oracle source to help us figure out what the temperature is expected to be on the day of the bet.

Central oracles also have their flaws. Weather.com could be hacked by a bettor who placed a lot of money on “yes,” for example. That bettor could hypothetically hack weather.com and alter the weather data to ensure he or she wins.
The prediction market Omen, for instance, is trying to fix this with a decentralized oracle that compiles data from a number of oracles and removes oracles that do not display accurate data.