Prediction markets are important because they create renewed value for accurate, fact-based information. The world of the internet is deeply entrenched in false information. While “false-facts” are not a new problem, with the proliferation of the world wide web, we have entered a new era of concern for good information. Currently, anyone can call themselves an expert and offer unsolicited advice.
How will prediction markets improve accuracy?
Prediction markets are as they sound: markets created from predictions that are formed from a collective of knowledge. So essentially, they monetize accurate information.
The benefit of these markets is that only accurate predictions are rewarded. Inaccuracy, however, comes with a loss. The way that decentralized prediction markets such as HedgeTrade and Augur work is that you can only earn money if you report quality predictions that turn out to be true. You are rewarded only when you are correct about the outcome of an event.
Fully decentralized predictions market (DPM) protocols currently built on Ethereum include Stox, Gnosis, and Augur. Related protocols on other blockchains include Hivemind built on Bitcoin and Bodhi built on Qtum.
For example, you’ve made a prediction that Amazon’s stock is about to drop. Using a decentralized predictions market, you stake money on that event. But then Amazon’s stock doesn’t drop, it goes up; that mistake will cost you whatever you staked. Additionally, this is noted on your reputation, so, your predictions will mean less and less if you continue to bet on inaccurate outcomes.
DPMs are possible because of the application of blockchain and its use of cryptographic blocks and cryptocurrency. This means that currently, you must hold cryptocurrency to participate in decentralized prediction markets.
This is also beneficial because the results are settled using smart-contracts with no third-parties. Because they rely on smart contracts, outcomes are automatically executed based on the outcome of the prediction. And presently, centralized prediction markets are illegal or restricted as they are considered a form of gambling.
A Promising New Market
Another potential benefit of the increased popularity of prediction markets is better, more accurate information. Many economic studies demonstrate that market predictions are effective because they gather information from many people who have different, valuable information to offer.
Significantly, because prediction markets have a monetary incentive to be correct, those who participate are more inclined to do better research.
Let’s return to our Amazon example. Your broker has advised that Amazon’s stock is dropping. So you panic and sell your stocks at a low price. As it turns out, that was a poor piece of advice, and the stock does not drop but goes up.
What do you do now? Well, nothing. You have lost money on a poor sale, and you wonder where your advisor got this information from in the first place. Your options are just to find a smarter broker. But you’ve still taken a hit that you could have hedged had you had better insight into the market.
It is these issues that predictive markets take on, and here’s how. Prediction markets are designed to gain information from multiple people in different fields.
Now let’s imagine that Amazon is rolling out a new program. The employees of the company see that it’s a good project and so they use prediction markets to bet on its success. Early adopters and investors will also be able to vouch for its success, and so they add to the prediction as well.
The reason that they are honest is not just because they are optimistic, but because if they are honest and Amazon’s new project succeeds, they stand to make even more money and if they overhype it they will lose out doubly; on the prediction market and the product.
The good news is this also works if Amazon’s stock is in fact about to drop. This is where a whole new market of honesty is made. Seeing the failed project, the employees and investors report this. They have now made a secondary market of the projected loss, and will now earn an income from reporting the loss.
Honesty becomes a valuable market because if you report false information you will be financially penalized for it. And your reputation on the prediction market suffers as well, making your word less valuable.
The profit is determined only by the outcome. So you can bet on the success of a stock with all your heart and money. But, if it is based on false information, this will be reflected in the outcome. If the stock plummets and you bet on its success, you lose your stake.
This can have multiple positive outcomes. For one, if a problem is reported, then the company will do whatever it can to improve. This is because failure comes with an even greater loss than before. Potentially, this also incentivizes higher quality work, because companies can no longer merely make promises, they will have to follow through on their word.
Wisdom of the Crowds
As you can see, prediction markets and decentralized prediction markets, in particular, offer a promising future steeped in better information.
Another positive of DPMs is that they are not limited by location or citizenship. That means that anyone with internet access and knowledge to share can participate. Currently, there are significant limitations to accessing centralized predictive markets. But decentralized predictions work with blockchain protocols on networks with varying levels of decentralization. This means not only are they secure, but they are accessible to anyone, anywhere in the world.
Monetary incentivization has proven to have a positive effect on information accuracy. So if you want to participate in the market prediction, you need to put your money where your mouth is. If ignorance becomes expensive, then people will work to contribute accuracy to the market.
Fully decentralized DPMs are third-partyless and without regulatory bodies. The only regulations are built into the program and run using automated smart-contracts. The program maintains the accuracy of the protocol and ensures that stakes are settled based on the terms of the contract. Also, currently, prediction markets are considered a form of gambling. Therefore they are illegal in several American states.
Value and prices of shares are determined by the market alone. So the value of a prediction is based on the need and perception of the market. The equilibrium of the market is therefore represented by the current perception of a market and the information offered by the crowd.
As the old adage goes, two heads are better than one. But 100,000 heads are way better than two.
DPMs have a great deal of potential for harnessing and improving the wisdom of the crowd. Because information is provided without borders, a much larger group of people with collective knowledge are contributing.
Not only do DPMs offer a broader range of information, but they also reward better information. Prediction markets are presently used primarily for predicting stock market behavior, and the outcome of sporting events. However, they have the potential to improve all kinds of information, and the dark days of fake news could be in sight.
What’s more, decentralized prediction markets can potentially make a whole new market for research. Right now, performing research studies is expensive, time-consuming and only ever offers limited results based on the control groups studied. This is because research has limited funding; people want good information but that is costly.
As a result, most medical research is funded by pharmaceutical companies that need to have profitable outcomes. However, if there was also a market that reported the success or failure of a new drug for users worldwide, we would have better results.
If prediction markets are successful, then the effectiveness of a drug would not be left for the advertisers and people profiting from its sales. Instead, the entire market that uses it could report on it publicly.
So, if good predictions are valued like assets, then everyone has a vested interest in forming better predictions.