Decentralized finance opens the door for developers and marketplaces to emulate many of the markets found on centralized platforms. Decentralized marketplaces have created futures markets, options markets, and other types of derivatives using blockchain technology. One interesting new option is the DeFi prediction market, one of the new decentralized finance tools made possible by the use of smart contracts.
What are decentralized prediction markets?
This new part of the decentralized finance world enables people to buy and sell contracts based on future events. Similarities can be drawn between prediction markets, futures markets, and betting. Whereas futures markets allow traders to predict the future price of an underlying asset, prediction markets enable traders to predict future events that don’t relate to an underlying asset’s price. Prediction market contracts often involve the outcomes of real-world events like election results, a company’s sales volume, and the weather. Because of the similarities between prediction markets and gambling, some states have outlawed using real money in prediction markets.
Many prediction markets use virtual tokens or “play money” in states where online gambling is illegal.
Decentralized prediction markets use smart contracts to eliminate the need for a central party or single operator to bring two parties together. Many of these DeFi markets use quadratic voting, allowing market participants to allocate more votes toward a particular contract if they feel strongly about it. The quadratic voting formula is the square of votes. This means, if it costs $1 to vote for an outcome once, it’d cost $4 for two votes, $9 for three votes, $16 for four votes, and so on.
There are numerous options available for anyone interested in participating in a decentralized prediction market. Augur, for example, is built using Ethereum’s ERC-20 protocol and enables user-generated markets and low fees. Augur’s user-generated markets allow a market’s creator to earn revenue through trading fees. Another popular option is TotemFi, a staking-based prediction market that enables non-punitive predictions and collaborative rewards. If a TotemFi market participant’s prediction is incorrect, that participant does not lose any of the digital assets they staked to make their prediction. Additionally, TotemFi pays rewards in BTC and their native token, TOTM.
Do prediction markets work?
In many ways, a prediction market is primarily a collective intelligence tool. It allows large companies and policymakers to gain insight into what the public thinks will happen in the future. These markets pull information from nearly every available source since those trading contracts use various decision-making methods. Although these methods should continue to become more accurate, there are numerous human biases to consider.
The contract prices in a prediction market fluctuate based on prevailing opinion. For example, if a contract stating “outcome A will happen” trades at 65 cents, the market believes there’s a 65% chance that the outcome will happen. Alternatively, if a contract stating “outcome B will happen” trades at 35 cents, the market believes there is a 35% chance that the outcome will happen.
Many prediction markets allow traders to sell their contracts before expiration. If a participant chooses to buy a contract supporting the correct outcome, they will get $1 when the contract expires. On the other hand, they’ll get $0 if they choose the wrong outcome. Still, as time passes, the contract prices may fluctuate in price.
Why do prediction markets work?
Rather than using historical data or computer algorithms, prediction markets aim to crowdsource predictions by aggregating opinions. Aggregating opinions from a wide variety of people is considered an excellent prognostic tool by many organizations. Decentralized prediction market participants live all around the globe, meaning their backgrounds, daily lives, and beliefs vary significantly.
Internal prediction markets have been used to forecast project management events. According to a study by Remidez and Joslin (2007), an internal prediction market was able to predict 24 of their 26 milestones accurately. Companies like Microsoft have even used internal prediction markets to determine product quality.
What are some of the advantages of decentralized prediction markets?
A decentralized prediction market offers numerous advantages over a centralized prediction market. For example, decentralized markets don’t require intermediaries, which means fees can be lower and privacy is enhanced. People can use digital assets to participate, meaning they don’t have to connect their bank account or debit card to the marketplace. One of the biggest advantages of using a decentralized prediction market is their global reach. Although centralized markets aggregate various opinions, they’re often more biased than global, decentralized prediction markets.
Since participation is open globally, decentralized markets often have more liquidity than centralized markets. Additionally, blockchain technology and smart contracts will allow decentralized prediction markets to advance faster than centralized markets.
Although decentralized markets are advantageous, they aren’t without faults. Many decentralized prediction markets allow anyone to create an event, meaning that some events may involve illegal or offensive activities. These controversial events might eventually lead to legislation banning certain events.
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