Practical Applications of Cryptocurrency: Decentralized Prediction Markets

What is a prediction market?

Shingai Thornton
Jan 12, 2016 · 4 min read

Wouldn’t it be useful if you could ask Google for the odds of any future event happening and have it respond with a reliable estimate? This is the ultimate promise of decentralized prediction markets, platforms which could prove to be valuable forecasting tools. Two of the most high-profile markets in development are Augur, which is being developed by the non-profit Forecast Foundation, and HiveMind, the brainchild of Paul Sztorc, a statistician who earned his PhD at Yale.

Prediction market users fund their accounts and then buy and sell shares of an event, similar to how you might trade shares of a stock. If the event occurs, the price of the shares goes to $1.00, if it doesn’t, the price goes to zero. The market price of the prediction, which roughly estimates the likelihood the event will occur, fluctuates until the event is over. If shares of “Bernie Sanders will win the 2016 Election” cost 45 cents, the market thinks he has a 45% chance of wining. Real money is used because people make more accurate predictions when they have something on the line.

Users profit by using their specialized knowledge to identify areas where they believe the crowd is wrong, and betting against it. Society profits by getting a tool for tapping into the “wisdom of the crowd”, a term describing the phenomenon of the average of a large number of independent guesses often being more accurate than the guess of any individual in the group. Augur’s Peronet Despeignes writes:

“That’s why the biggest beneficiaries of prediction markets might not be the people who trade in them, but the rest of us who can use them as a kind of easy weather report on where things stand and where they’re headed on multiple fronts. In this sense, prediction markets can be a democratizing force that distributes access to valuable information more quickly and more widely. That information tends to be of remarkably high quality. They’re not perfect, but it turns out that prediction markets are more accurate on average than the usual surveys, industry forecasts, experts and pundits. That’s clear from a massive and ever-growing library of case studies and academic research.

Why decentralize?

Prediction markets aren’t new. The Iowa Election Market has been accurately picking election winners since 1988. In 2001, DARPA’s attempt to create a market for events in the Middle East was shutdown by Congress and dismissed as a “federal betting parlor on atrocities and terrorism”. Intrade achieved considerable success until it was forced to shutdown as the result of a probe by the CFTC. Predictit has CFTC approval and is gaining traction, but is limited to U.S election markets and citizens. These markets all require(d) users to fund their accounts with traditional payment methods.

Fairlay and Predictious are Bitcoin based, global, and have a wide variety of market types, but are still centrally managed. Decentralized markets will have a number of differences and advantages. Most importantly, market creation will be left to users. Any imaginable event will be predictable by anyone with internet access and markets with billions of participants will be possible.

“I assumed that the time would come when there would be a science in which things could be predicted on a probabilistic or statistical basis.” — Isaac Asimov

What can we use them for?

Aside from the obvious use cases (ie: sports, elections) there are many more productive possible applications. A 2008 CIA report details a few. Google has used prediction markets to “forecast product launch dates, new office openings, and many other things of strategic importance.” An experiment conducted by Hewlett Packard and Cal Tech “gave credence to the theory that prediction market prices act as probabilistic estimates of future sales targets.” U.S. pharmaceutical giant Eli Lily found that “prediction markets outdid conventional methods in forecasting outcomes of drug research and development efforts.” The report concludes:

“For the US Intelligence Community, prediction markets offer a method by which to improve analytical outcomes and to address some of the deficiencies in analytical processes and organization. In the realm of intelligence analysis, prediction markets can contribute to more accurate estimates of long-term trends and threats and better cost-benefit assessments of ongoing or proposed policies.”

Augur as a Social Good highlights some creative possibilities; farmers in the developing world could use markets to hedge against bad crop seasons, or citizens worldwide could incentivize government and corporate whistleblowing by betting information won’t be released. Perhaps markets could be created to incentivize scientific research; scientists would profit by achieving goals that most people want, but the markets don’t think will be met by a certain date (ie: cures for terminal illnesses, major technological advances). Professors and researchers, especially in the social sciences, could use them as valuable experimental tools.

Conclusion

There is a demonstrated demand for prediction markets, with a number of healthy, active centralized markets running, and Augur recently raising $5,318,330.83 in crowdfunding from 4,851 users. HiveMind has received funding from well known Bitcoin entrepreneur Roger Ver, and prominent developers have contributed to the project.

Prediction markets stand out as an application where cryptocurrency currently offers clear and substantial benefits over traditional forms of money. Automated, global markets with near instant settlement and transaction times wouldn’t be feasible with cash, checks, credit cards, wire transfers, or gold. Prediction markets have proven their utility in business case studies and academia, but there is no simple way for the average person or organization to use them productively, largely because of the inability to quickly create large, diverse markets on any topic.

By providing secure and user friendly prediction market platforms, Augur and HiveMind might encourage adoption of cryptocurrency because users will have no other way of participating. The potential for long term growth is enormous, it’s no surprise that prediction markets are often touted as a possible “killer app” for cryptocurrencies. Despeignes writes:

“Prediction markets are essentially binary options or idea futures. According to the Bank of International Settlements, the outstanding notional value of all options, futures and other derivatives is about $700 trillion. If Augur succeeds and gets even 1% of a 1% slice of this total figure, that’s $70 billion.”

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