Crypto Prediction Markets — What Are They and How Do They Work?
Crypto Basics

Crypto Prediction Markets — What Are They and How Do They Work?

11 хв
1 year ago

Today, CMC Academy dives into the crystal ball of finance, called prediction markets, where people bet on all kinds of future events to make money.

Crypto Prediction Markets — What Are They and How Do They Work?


If you like predicting things — like the next winner of the Best Actor Oscar or the next crypto to be rugpulled, for example — then prediction markets are where you need to go.
Crypto prediction markets allow users to earn money by predicting random crypto-related events, like the impact of the Merge on ETH’s price and even the next meme from Elon Musk.

But wait, before we dive any deeper, don’t take every word above (or below) to be financial advice!

In short, prediction markets are where you bet on the outcome of prevailing events.

Since these bets are placed on the outcome of public events, much of the information is already accessible, so you can make a somewhat informed decision.

Prediction markets are not so complex that you need to do a PhD in information gathering before you can make a decision, and they're not so easy to game that you can delegate to your Golden Retriever.

To find the middle ground between these two extremes, let’s understand:

  • What prediction markets are;
  • Why we need decentralized prediction markets, and how some decentralized prediction markets work.
Prediction markets are similar to futures contracts — just like in futures, you are merely speculating on the outcome (the price of security/outcome of an event) of the underlying contract. Usually, in a prediction market, any speculator can open trade as long as there is an opposing party.
Similar to traditional finance, there are several platforms that offer predictions in crypto too — the model allows you to speculate on the outcome of events using crypto assets, such as stablecoins. There are a few different protocols in crypto that offer users the ability to create their own prediction markets.

How Do Prediction Markets Work?

Prediction markets have a vibrant history and have been known to exist for hundreds of years. Imagine placing a bet on whether the king will marry the queen of a neighbouring kingdom in the early 1600s! But, like your grandfather sipping his whiskey from a flask would say, the times have changed.

To participate in these markets now, you need to buy contracts — think futures markets. However, the key difference between the two is that you are not speculating on the price of the asset, but rather on the outcome of an event.

As with most financial markets, the price of a prediction is based on the price that the people are willing to pay for that bet. Naturally, you’d expect people to place a higher value on the next president of the country as opposed to the winner of the local football tournament. These bets can also be based on certain parameters, such as how the market will perform after a certain political candidate gets elected or so on.

And you know how these prediction markets help analysts like us? Market sentiment.

The amount of money that people are willing to bet on a specific outcome is one of the factors that can help us understand the sentiment of people in the market. This kind of data — given that we have so many reliable data analytical tools now — would be extremely useful for any marketing/advertising agency that has been trying to design its campaigns for a specific group of people.

These markets tend to be more reliable than the YouTube-popular self-proclaimed pundits/gurus who think they have the power to change the world.

There are different types of prediction markets that exist, and we’ll quickly go over two of the most important ones.

Continuous Double Auction Prediction Markets

Continuous double auction prediction markets work just like stock markets. The participants can trade their bets via the prediction market operator where that operator maintains the ledger/order book of trades. These kinds of markets are usually seen online where almost everyone can participate in.

Decentralized Prediction Markets

These are crypto-based prediction markets where participants are able to bet/speculate on a variety of real-world events, such as political elections and the economic growth of countries, among others. Augur is an example of a prediction market in crypto. It, however, soon became infamous as people started betting on political figures’ assassinations. The platform has noticeably lost its charm and currently has only $1M worth of TVL.

But wait, which one’s better? Rather, which one should you go for? It all depends on your own likings and the kind of bets that you want to place. For the sake of this article, we’ll focus on decentralized prediction markets.

Decentralized Prediction Markets

Decentralized prediction markets are…well…decentralized, and, hence, no one can alter anything in these markets.

Centralized prediction markets can be altered to the benefits of the shareholders.

And after all, it’s 2022!

Jokes aside, the move to decentralized prediction markets is crucial because the centralized markets are often marred with conspiracies and the fact that they are “closed”. This does not give market participants the ability to create their own markets and set their own parameters. Participants are often left to deal with the markets that are permissible by regulation (not hearing this for the first time, I assume?).

As a result of the looming regulatory concerns over these markets (coupled with a capping on the amount that participants can bet), these centralized prediction markets end up being illiquid. With so many regulations and controls, it is really hard to find users who’d be willing to trade shares so frequently!

And that is why we may need decentralized prediction markets.

As opposed to the centralized ones, the rules of the markets are very often hardcoded into smart contracts and hence hard to change — unless there is something specific that needs to be changed. Another crucial benefit to having decentralized prediction markets is that they are accessible to people all over the world.

Let’s discuss decentralized prediction markets in detail!

How Do Decentralized Prediction Markets Work?

Let’s understand how decentralized prediction markets actually work. Just like any other market in crypto, they are based on smart contracts. That is, all participants buy the shares of the bets they make.

And in any case, there are two types of bets that are placed:

  • Either it is in favour of the outcome (we can call it the “yes” bet), or;
  • Against the outcome (the “no” bet).

Each market has a different set of parameters that decide the price of the predictions. If I were to bet on you winning the next presidential election, but you end up getting caught in a scandal, then surely there will be more people who would predict “no” to that outcome. It will drive the prices of the “no” outcome higher and the prices of the “yes” outcome lower.

Understanding Polymarket

Polymarket is one of the leading decentralized prediction markets based on the Polygon blockchain. It lets you trade on outcomes of future events that are related to several topics such as politics, culture, entertainment, financial assets and so on.
  • To interact with the market on the application, you are required to hold USDC. All the transactions go through USDC (including the amount that you have to pay for gas).
  • Since the application does not rely on any centralized intermediary, it relies on AMMs (automated market makers) to create liquidity pools.
  • These pools consist of both the “Yes” and “No” outcomes. Additionally, users are incentivized to provide liquidity to these pools and in return earn a proportion of the trading fee.

Information Markets

The markets that are created/listed on Polymarket are known as information markets. Participants buy the shares in these markets to place their bets. The price per share is often subject to:

  • the probability of the positive outcome occurring, and
  • the probability of the market moving in either direction

The price of each share ranges between $0 and $1. The application supports three different types of markets:

  • Binary: A market that offers two options.
  • Categorical: A market that offers multiple options/outcomes.
  • Scalar: A market that offers range-based options (e.g.: what is more likely the selling price of a car: 5000/10000).

Users normally buy shares when they think that the probability of a certain event happening is quite high — for instance, they believe that there are 85% chances that a particular team in a sports competition would win.

If the outcome is positive, then they make money.

If not, then they lose everything.

The application relies on an optimistic oracle which help feeds data from external sources. Remember that blockchains or blockchain-based applications themselves cannot directly interact with the external non-permissionless blockchain world. To facilitate that interaction, oracles are used.

The application relies on token incentives and rebates as a means to acquire and retain users and incentivize them to provide liquidity to the pools.

Getting Started With Polymarket

To get started with Polymarket, make sure that you have your MetaMask wallet set up on your browser. Head to the main page of the application and connect your wallet. You can do that by clicking the “Sign Up” or “Login” button on the top-right corner.

Once you have connected your wallet, you can start interacting with various markets.

You will be given various options to choose from. For the moment, let’s select crypto.

Let’s place a bet on when “When Will Ethereum Merge to Proof-of-Stake?”

As you can tell, the probability of the Merge happening by August 1, 2022 is only 2%, while the case of it not happening is a whopping 98%. But, if we scroll down, we’ll notice that the market participants believe that the probability of the Merge happening by January, 2023 is almost 92%. This is where we can place our bet.

To purchase a share on the platform, you will have to select the “Deposit” button.

You are advised to choose the Polygon network as it will help you avoid transaction fees. Note that you are required to deposit the amount separately to the platform as it uses a “proxy” wallet, and your MetaMask wallet does not interact with the platform directly.

As an example, we will deposit $5 to experiment with this particular market. Now, when you have deposited the amount, head back to the original screen and purchase the shares.

Let’s buy $5 worth of shares for the “Yes” outcome.

When prompted, approve the transaction. Now that you have purchased these shares, you can view them in the “Portfolio” tab above.

You will be redirected to this screen where you will be able to see all of your trades.

When you need to close a position, you can simply trade the shares back.

Getting Started With Augur

Augur is an emerging prediction markets protocol that currently has $1.03M TVL. While the protocol itself is quite old, its v2 was released in 2020. To trade on Augur, you need to use DAI as the base trading currency. It is built on a complex order-book-style application.

To get started, we need to understand the basics of the platform.

The Augur Token (REP)

Interestingly enough, the token of the platform is known as REP, which stands for Reputation token. Since users either bet on an outcome and/or create a new market where other users can place their bets, they are staking their “reputation” to it.

You can easily buy REP on any of your favorite exchanges. To see which exchanges have the REP token, head to CoinMarketCap.
It is also important to note that you can access Augur by installing its web application as well.

Now that you understand what its token is for and how to install Augur, let’s get started with the walkthrough!

Make sure that you’ve already set up your MetaMask and have the REP tokens to place a bet. Once that is done, open the app. You will see a list of different markets you can bet on. Just like Polymarket, you will find different types of markets here. These may be anything from cryptocurrencies to politics or geography.

You can place your bets on any of the questions displayed in front of you. The percentage represents the likelihood of an outcome happening the way it has been mentioned.

Let's take ETH’s price prediction as an example!

You can also look at the potential outcomes that are available to be placed a bet on.

Depending on which price prediction you want to place your bet on, you will be able to buy (for “Yes) or sell (for “No”). Remember that this is an order-book-style betting and, hence, you’ll need a taker on the opposing end of your bet for your bet to go through. For instance, if you bet $50 for “Yes”, then there should be someone who’s willing to place a $50 for “No”.

Once done, you will be able to track your orders in the “My Positions” tab.

Is It Profitable to Trade in Prediction Markets?

Prediction markets overall currently have a TVL of less than $7M. Of all this, Polymarket stands at the top with almost $5M in its TVL. While it is hard to delineate the profitability from a prediction market, if someone is, deep into a certain type of market (such as political, cultural or financial), then they can most certainly do their own research and place their bets.
It is safe to say that betting on prediction markets is as good as gambling. The only difference with decentralized prediction markets is that you have the option to trade against someone else as opposed to playing against a centralized intermediary (such as in casinos). If you place your bets well and follow the market sentiment correctly, you do stand a chance of making some money. However, as with anything DYOR is highly recommended.

Closing Thoughts

Prediction markets have not yet seen widespread adoption. Perhaps because the entire industry has been considered a speculation. As such, you see the meagre volume on platforms like Polymarket. It still is a speculative market where users stand to make some money every now and then.

The fact that users are willing to pay, say, $75 for a positive outcome and $40 for a negative outcome implies that 75% people think that the result will be positive and 40% people think it will be negative.

Any market (whether it is one where people exchange goods/services or a market where people trade assets) is bound to react quickly to changes in the sociopolitical, cultural and economic environments.

This is usually the case because there are certain individuals in the market who are slightly ahead of the curve in terms of acquiring, understanding and taking action based on the data they receive. Just recall $UST’s de-pegging event and the quick outflow of funds from Anchor. It is because of this very nature that prediction markets are considered a better utility tool for corporations/organizations to gauge the market than doing internal rounds of predictions.

This article contains links to third-party websites or other content for information purposes only (“Third-Party Sites”). The Third-Party Sites are not under the control of CoinMarketCap, and CoinMarketCap is not responsible for the content of any Third-Party Site, including without limitation any link contained in a Third-Party Site, or any changes or updates to a Third-Party Site. CoinMarketCap is providing these links to you only as a convenience, and the inclusion of any link does not imply endorsement, approval or recommendation by CoinMarketCap of the site or any association with its operators. This article is intended to be used and must be used for informational purposes only. It is important to do your own research and analysis before making any material decisions related to any of the products or services described. This article is not intended as, and shall not be construed as, financial advice. The views and opinions expressed in this article are the author’s [company’s] own and do not necessarily reflect those of CoinMarketCap. CoinMarketCap is not responsible for the success or authenticity of any project, we aim to act as a neutral informational resource for end-users.
1 person liked this article