From U.S. elections to World Cup soccer games, to whether or not 24-year-old Ethereum co-creator Vitalik Buterin has a girlfriend or when he might find one, prediction markets allow the ‘wisdom of the crowd’ to speculate on the outcomes of future events.
The Efficient Market Hypothesis states that assets’ prices fully reflect all available information, and this underscores the ability of the prediction market to aggregate information and make accurate predictions. Thus, the concept of a prediction market is that the market price of a share will be an indicator of the likelihood of the outcome occurring: people who forecast the correct outcome win money, while those who forecast incorrectly lose out. As well as being an effective tool for hedging against adverse outcomes, the market can also act as a repository of crowd-sourced knowledge for journalists, investors and policymakers.
A prediction market by its very nature is decentralised: collective wisdom over expertise decisions, making it a market that appears to be a ready-made match for a blockchain solution.
Nodari Kolmakhidze, Chief Investment Officer at Cindicator, says decentralised prediction markets are the classic use-case for Blockchain technology, because “this is one of the industries that require transparency in the trading process and rewards/bets management.
“Decentralized prediction markets usually don’t require trust for the market organizer – and this is one of the advantages of Blockchain-based prediction markets.”
One of the very first Dapps, (apps powered by blockchains but operated by no single entity) built with Ethereum’s (ETH) blockchain, the Augur prediction market launched in July this year as a trustless, decentralised oracle and platform for prediction markets.
It’s a platform for users to create a prediction market and use ETH or REP to buy ‘shares’ to bet on the outcome of events. Event outcomes are determined via a decentralised vetting process: reporters receive fees to create and moderate the market and they can lose REP tokens if they incorrectly report outcomes and are challenged by other REP holders.
According to the Augur white paper, centralised prediction models come with significant risks and limitations: “they do not allow global participation, they limit what types of markets can be created or traded, and they require traders to trust the market operator to not steal funds and to resolve the markets correctly.”
A decentralised model, however, hopes to eliminate these limitations, offering open and crowd-sourced speculation at low cost. Decentralised networks such as Bitcoin or Ethereum can remove the risk that self-interest will turn into corruption or theft.
The only significant expenses for participants are compensation to market creators and to users who report on outcome of markets once the event has occurred.
Kolmakhidze explains that “prediction markets are made up of exchange-traded contracts that allow participants to trade the outcome of events. In most cases, the price of such a bet is an indication of how traders are assessing the probability of the event, thus prediction market contracts are usually traded between 0 and 100%.
“The most important part is that any user has a motivation to try to guess the right outcome, otherwise he will suffer from a financial loss.”
Augur says its incentive structure is designed to ensure that honest, accurate reporting of outcomes is always the most profitable option for Reputation token holders. This results in a prediction market where trust requirements, friction, and fees will be as low as competitive market forces can drive them.
The decentralised exchange protocol used by Augur, 0x, boasted a market capitalisation of $322 million at its July launch, according to Cryptoglobe. As of September, Augur’s REP token has a market cap of $142 million, taking 47th place on Coinmarketcap’s list of top cryptocurrencies.
The decentralised prediction market was off to a smashing start when it launched on Ethereum’s live blockchain in July this year, briefly overtaking the most well-known decentralised application, CryptoKitties, in terms of number of users.
Just 12 hours after Augur’s launch it become the 5th most popular dapp on the ethereum blockchain by total users, according to DappRadar.
Promise of low fee wagering and a fully open source, decentralised prediction market had fueled high hopes for quick growth. But Augur’s fall from grace has been equally swift, dropping from its prestigious ranking as one of the most used Ethereum DApps, to an insignificant handful of just 66 users in August.
Crowds were attracted by Augur’s supposed benefits of low trading fees, user-created markets, automated payouts, and an open to all permissionless protocol which allows anyone, anywhere in the world to participate.
So, what caused Augur’s sudden downfall? Like other innovative projects in the tech world, the user experience hit up against some yet-to-be-ironed out kinks: users quickly ran into problems such as the Augur app repeatedly disconnecting and slow syncing.
Platform founder Joey Krug, voiced his frustrations on Twitter: “Everyone knows the Augur UX is bad right now because of issues that only appeared on mainnet in production, pointing it out on twitter isn’t saying anything useful/productive.”
What’s clear is that there’s a current mismatch between hopes that the decentralised prediction platform model will soar, and their inability to attract and retain users.
Kolmakhidze explains that “we can see right now there is a clear lack of users for decentralized prediction market platforms. Some platforms may have less than 100 users while having a market capitalization of hundreds of millions.
“Such high capitalizations may represent the hopes and anticipation of growth of the whole decentralized prediction markets industry.
Despite the challenges facing blockchain based prediction markets, Augur is not without competitor rising stars which continue to emerge and innovate in the prediction market universe:
Prediction market Bodhi says it is committed to providing the next generation prediction market, it focuses primarily on the Chinese market and is one of the first and largest dapps on the Qtum blockchain.
Gnosis is a prediction market which uses Ethereum smart contracts, but relies on a centralized Oracle for judging results, instead of token holders.
Next-generation hedge fund start-up Numerai has released numeraire tokens to its network of 19,000 data scientists who improve its calculations for making real bets on the stock market.
And Artificial Intelligence Exchange (AiX) relies on blockchain technology and Artificial Intelligence to connect traders across markets, removing the need for inter-dealer-brokerage.
These alternative models provide a glimpse into the future of how the market could evolve and mature.
“The winner will be a project that will basically create this market for potential clients – there aren’t many at the moment – show why decentralized prediction markets are a solution that the world needs, and why this solution could help to resolve clients’ problems, says Kolmakhidze.
“But I’d refrain from pointing exactly to some existing projects, there are many competitors in the field, and we will see who will win their market over time,” he says.
According to Investopedia, we’re living the golden age of data and statistical utility with the benefits of data analytics and Artificial Intelligence coming together with the blending of economics, politics, and more recently cultural factors, which have made the demand for prediction even greater.
Despite the potential for the decentralised prediction model to takeover, Kolmakhidze adds that “time will tell if the platform can attract the kind of users it is aiming for and create a truly original means of prediction.”
Decentralised prediction models are still new comers on the block, and for many, it seems building a history of reliability will be key before serious money and numbers of users decide to move in.