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prediction markets on blockchain

Demystifying Prediction Markets on Blockchain

written by Samrat Roy Chowdhuri September 9, 2017

Imagine an open, trust-less, permission-less platform that can reward humans and programs and machines for predicting the future! Yes, I am talking about prediction markets on blockchain.

Decentralized platforms will change almost everything about how we function in our society. It will change the way we share wealth, may be stop environment degradation, assist our fight against climate change, redefine organizations, etc.

What are Prediction Markets?

An example to start with – we Indians are great fans of cricket matches and if its an India versus Pakistan match, its the mother of all matches. So before the match is played out or during the course of play, you bet (predict) on a certain team to win the match.

For 7 rupees bet for a Pakistan win and a 3 rupees bet for an India win. Now once the match is played out and the winner is decided, the individuals who had bet Rupees 7 will receive Rs 10 if Pakistan win while those that put their money on India will receive nothing.

Similarly, if India wins, individuals who bet Rs. 3 will receive Rs. 10 while those that put their money on Pakistan will receiving zero.

Now this activity is done by the prediction markets – markets that are created for the purpose of trading the outcome of events. You are basically a participant of this market, betting against each other how an outcome will turn out.

There might have been a clampdown on prediction markets in most of the countries (read gambling) but they still exist but have failed to flourish. There are many reasons for it, but that is not the discussion point of this article.

Prediction market is like the stock market, except that you do not buy stocks in companies. But you buy stock in outcomes.

The power of prediction markets rests in “The Wisdom of the Crowd,” a well-studied phenomenon that argues certain predictions made by a large enough sample size will be more accurate than ones made my experts and pundits.

The Farmer Example

Let us consider another example.

A farmer in India earns an average of Rupees 72000 (around 1107 USD) per year. Say to break even he needs to earn Rupees 60000.

However his income is variable and is dependent on external factors like rainfall, cost of crop after harvesting, fertilizer costs, etc.

So if conditions are favorable, the farmer can earn around Rupees 85000, if conditions are optimal the farmer can earn 75000 and if conditions are unfavorable the farmer will earn around Rupees 65000.

Thus if conditions are favorable and optimal, the farmer will be able to break even.

But if the conditions are unfavorable the farmer will be unable to break even and will incur losses. At the same time, it will become really difficult to sustain unless he has some savings in bank deposits, etc.

With a prediction market, the farmer can gauge or bet on whether the current year will face drought or receive proper rainfall.

He can invest Rupees 5000 predicting a drought assuming the likelihood of a drought occurring to be 50/50. So if a drought does occur, he wins some money to help him sustain although he has incurred losses from his harvest.

If there is no drought, he loses the amount he bet but he still has enough from the sale of his harvest to sustain.

So prediction markets are actually helping him diversify which was never possible before. Like the farmer can make a prediction of potato on a particular date to compensate or regain changes in prices if the price of potato falls.

This is just a simple example, but I hope you got to understand how powerful prediction markets can be for the people who do not have proper access to the financial system.

Decentralization – Prediction Markets on Blockchain

The full potential of anything is revealed when it is made open. Consider the world wide web which is open and has led to innovative ideas turning into great inventions in a short span in this millennium.

Prediction markets helps to democratize access to information and data. This pits them directly at odds with powerful interests that make a living off of monopolizing access to information.

Implementing prediction markets on the blockchain will ensure the following benefits:

Honest Outcomes

A blockchain system is decentralized. The system is run by the users of the ecosystem.

Every user can have a reputation score mapped with his profile. A high reputation score will mean better outcome prediction, while a low reputation score would mean the opposite.

Now the markets can always call a large number of users to predict the outcome. This would also make collusion impossible and lead to honest outcomes.

Near-to-Accurate Outcomes

When you implement prediction markets on the blockchain, you are removing entry barriers and betting limits.

You are pushing markets across borders, bringing in more people and more cash.

This would certainly lead to prediction that are accurate or near-to-accurate to the original outcome.

Blockchain Prediction Markets Can’t be Shut Down

Previously there has been many instances of prediction markets being shut down for various reasons.

However once prediction market is implemented on blockchain it can’t be shut down because of its decentralized nature. There are no centralized server. The application database practically resides on every computer.

Safe and Automated Payments

If the blockchain application hosting the prediction market is capable of running smart contracts, then it can collect payments while a prediction is being made.

Similarly once the outcome is fed into the system, it can also distribute to the winners. There is no manual intervention required.

Crowdsourced Reporting

In a traditional prediction market setup, one person determines the final market outcome which means there can be mistakes, lies, corruption and manipulation.

With a decentralized prediction platform, this reporting is done by thousands using a consensus based system.

How Prediction Markets on Blockchain Work – Augur Case Study

This is a case study of how a prediction market built on Augur work. More details on Augur are provided later in the post.

Augur has a digital token called REP or REPutation. Using this cryptocurrency you can not buy or sell stuff on the Augur network.

However it tracks your reputation – how often you tell the truth while reporting the outcome.

For every correct reporting of the outcome, your REP is returned and you are paid in cash. However for every incorrect outcome, your REP is gone.

Also the users who predict on the platform are paid in money.

In a sense the platform provides a glimpse into the future – forecasting correct results of events that are yet to occur.

Platforms Providing Prediction Markets on Blockchain

The following are some of the platforms providing blockchain prediction markets:

Augur

Augur is a decentralized prediction platform built on the Ethereum.

It is one of those blockchain projects that are closest to release a commercial product. The underlying token powering the ecosystem is called REP (REPutation).

The REP can be thought of as a score of an individual within the Augur network.

According to Augur website –

Those who hold Reputation are expected to report accurately on the outcome of randomly selected events within Augur every few weeks. If holders fail to report accurately on the outcome of an event, or attempt to be dishonest – the Augur system redistributes the bad reporters Reputation to those who have reported accurately during the same reporting cycle.

Augur users are expected to intermittently answer questions to help resolve markets.

If the prediction is accurate, they are rewarded with a fee taken from the market. And for every inaccurate prediction, a penalty is imposed.

The network is able to come to a consensus on each outcome based on these responses.

In Augur, the prices of the shares you trade in any event adds up to one dollar. If you buy a share at even odds it will cost you 50 cents. So if your prediction matches the outcome, you would be rewarded with 1 dollar.

If your prediction is wrong you lose the money spent in buying the stocks in events.

With time as more and more users buy shares in the event, the price fluctuates. The share price of one of the outcomes will increase and similarly the price of the other will reduce.

Using Augur, you can create your own decentralized prediction market at low fees.

Truthcoin/Hivemind

This is a peer to peer oracle protocol which absorbs outcome so that bitcoin users can speculate in prediction markets.

Bitcoin users can create their own prediction markets and participate in them. According to their website –

Hivemind has users, just like Bitcoin, but it also has “employees”. These employees work for “Branches” (each Branch resembles a new InTrade), and vote on “Decisions” (election outcomes or price-feeds), which resolve “Markets” (the trading-arenas defined by one or more Decision). Users are free to create any Decisions or Markets they like, although they compete economically for scarce “Decision slots”.

Gnosis

This is another decentralized prediction market built on Ethereum.

It offers two tokens – GNO and WIZ.

Users on the Gnosis network can lock down their GNO tokens and receive WIZ. 30% of these is received instantly while the other 70% is received equally over a time period.

Users can use WIZ tokens on the network to create prediction markets, pay trading fees, speculate on event outcomes among others.

Future of Prediction Markets on the Blockchain

The world is rapidly moving towards complete financial inclusion. With faster and wider acceptance and implementation of blockchain technology, blockchain prediction markets will ensure that the future is foreseen to a large extent.

Coupled with machine learning, this can mean much more.

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