Getting An Edge On Augur: A Few Thoughts On Beating Prediction Markets
Wanted to share some early, developing thoughts on how to play Augur’s prediction markets. To get some context, if you haven’t yet, check out my recent post The Radical Potential Of Augur. Augur launched just last week and you can download it here and connect on Reddit or Discord to the friendly, always helpful Augur community.
Last year, Ari Paul wrote about the importance of table selection. Trading something like stocks or Forex is like playing at a poker table with world-class pros while trading crypto is like playing at an amateur table, he noted. Mature, crowded markets are highly efficient and tough to beat. It’s far easier to get an edge in less competitive markets. Since he wrote this, the crypto markets have become more competitive. But luckily, we now have a new table in town: Augur.
Because it’s not well known, lacks liquidity, and is hard-to-use, Augur is a highly inefficient market prone to irrational pricing. Someday it may be the most efficient market in the world, but that day is a long ways off. Today, Augur is the table in the dark corner of the casino shrouded in cigarette smoke. Few folks will venture near this table or even notice it exists. This means less competition, more opportunity.
Think Short As Well As Long Term
The great thing about prediction markets is that you can buy and sell your predictions at anytime. In a traditional bet you have to wait till the outcome resolves e.g., the Super Bowl happens. But in a prediction market you can exit your position at any point. This means that when considering a prediction, the question of how it will trend in the short term is just as important as its final outcome.
For example, if you’re betting during summer on the Super Bowl winner you might sell shares on a team that has a disproportionately tough schedule in the first half of the season. Then, half way through the season, you can probably buy back at a lower price, assuming the team lost against some of its tough opponents.
Here’s another example. Let’s say I’m bullish on Ether long term but think the bear market will hold for some time and prices will drop lower in the coming months. Even if I think it will hit 2000 USD by August 1st, 2019, I may sell shares in this outcome as I expect I will be able to buy shares back at a lower price within the next few months. Taking this approach is essentially betting on volatility, which is generally not a bad idea in these early days of crypto.
Just be cautious with this approach in low liquidity markets, as you might not be able to exit your position in the short term.
Consider Built-in Bias and Self-Selection
A price in a (liquid) market is simply what the consensus thinks, so to beat a market you have to go against consensus. So it’s useful to think about how market actors are biased. Whenever humans are doing something hard and abstract that we didn’t evolve for like forecasting the distant future, we rely on mental shortcuts that are efficient but often irrational. I won’t dive into cognitive biases here as it’s a huge topic, but I’ll talk about one bias that is bound to affect Augur at this point: Self-selection.
The folks who play Augur at this point in time are going to be disproportionately bullish on Augur, Ethereum, and crypto in general. Why? Because only folks who are really into crypto will have heard of Augur, let alone put up with the hassle of using it at this point.
The fact that you have to download Augur, sync a local DB, use something like Metamask, and actually *own Ether* (or know how to access it) to trade on Augur, serves as a de facto barrier for anyone who is not hardcore into crypto. This is like if you had a market speculating on the future price of tobacco where only tobacco farmers could participate. The prices would be excessively bullish.
So the markets on crypto prices have the most liquidity (because its what interests Augur traders the most) and the most bias. Liquidity + Bias = Opportunity. So I think right now, markets predicting positive price outcomes in crypto will generally be overpriced.
For instance, as of this writing the market thinks there’s a 87% chance Augur’s REP token will be above $32 at the end of the year (it’s trading at $29.55 right now). That’s the type of market that is likely to be overpriced. And because Augur is built on Ethereum and attracts folks from the Ethereum community, positive outcomes for Ether are likely to be overpriced in Ether vs. Bitcoin markets.
I expect this effect will be amplified or mitigated at different points in time depending on whether the market is in a bullish FOMO or bearish phase. So this pro-crypto bias could be offset at certain points in time by more powerful biases e.g., if the broader crypto market is panic selling, temporary fear could irrationally drive down predictions. The bias may also be offset by the fact that Augur can be used to effectively short crypto (though it can also be used for leverage so I’m not sure the net effect here).
Collect Market Creator Fees
Since a market creator collects small fees whenever anyone trades, if you get enough volume in your market, you can get some passive income. But attracting liquidity is a chicken-and-egg problem: in a market where its costly to trade, people only want to trade when others are trading. Plus, by design, the markets with lower volume are less visible in the UI.
A few ideas on how to get around this…
Try creating markets for down the line. Right now there are markets for most major events in the near future, but few longer term ones. But since Augur is likely to not really take off for another couple years, it may be profitable to create markets for the Super Bowl winner in 2020 or 2021. By that time, Augur may have enough users to earn your market meaningful volume.
You might also create secondary markets for multiple choice outcomes. Augur currently has a limit of 8 outcomes when you create a multiple choice market. For instance, the current Super Bowl winner market has just 7 teams and “Other” listed. You might create a secondary Super Bowl market with a batch of 8 other teams. Right now, in mainstream betting markets, the 49ers are drawing the highest betting volume for Super Bowl winner, but I don’t think there’s even an option to bet on the Niners on Augur. This secondary market idea also applies to other sporting or political events like winner of the 2020 Democratic Presidential Primary. While markets predicting cryptocurrency prices are drawing the most volume right now, I think sports and politics markets will take off in the next phase as the user base gets more mainstream.
If you have enough capital at your disposal, you might place orders and fill them yourself i.e., buy from yourself, using multiple accounts to infuse liquidity into your market. As of this writing, a market with over 10k USD in volume, would rank in the top 5 markets by volume. You could also use this approach if you see a market you want to trade in but the transaction fees are excessive. You could start a market on the same outcome with lower fees and infuse it with liquidity. I think this is a win-win, since other folks will also get to trade on the same outcome with lower transaction fees (though it may be annoying for folks who already traded in the initial market).
Here’s an idea that probably wouldn’t work but is a fun thought experiment: create a market to bet on the volume of your own market. For example if you create a market on whether Dwayne Johnson will be elected president in 2020, create another market for “Will Volume In The Will Dwayne Johnson be Elected President” market exceed X amount. This might incent traders buying shares in the second market to trade in the first. You also might try to get things going in your market by offering to buy or sell a low amount of shares at a crazy bargain. The expected loss on that trade may be offset by getting liquidity into your market.