Truth, in the times of Bitcoin — Why DLCs are such a big deal!
At Cinepolis, more often than predicting Cricket or Football matches, we’d hazard a guess on which movies will do well and which wouldn’t? Multiplexes are in F&B Business, the bigger the crowd the better would be our chance of upselling an expensive soda.
That’s how I discovered Predictive Analytics and Prediction markets. Moneyball and Intrade.
The first one stems from the belief that the future is an extrapolation of the past. The latter, from the view that if you can offer the right incentives, the wisdom of the crowd will reveal the future.
Fast forward 10 years, future-gazing is a massive industry dominated by predictive analytics aided by advancements in machine learning and massive troves of data and computational power. Prediction markets, on the other side, seem to have missed the boat. Or, has it not?
Intrade, the most popular prediction market, has closed down after regulators stalled unregulated options trading. Hollywood stock exchange still remains a game, on the fringes. What happened to Prediction Markets?
What are prediction markets and why the future didn’t arrive, so far?
I see every view, transaction, or instrument, financial or otherwise, as a kind of bet. And we already use many of them :
- Buying insurance is me betting that I’d meet an accident and will recoup more than what I’d pay in premiums, but the insurance seller is betting that I wouldn’t, and hence end up paying more in premiums than my medical fees.
- Buying a stock is a bet that the company will do better than previously anticipated, whereas selling a stock is a bet that the company will do worse than previously anticipated.
- Joining a startup with stock options over a job at an MNC is a bet that the expected upside is bigger than the difference in the salary.
- Buying an umbrella is a bet that it will rain, buying sunglasses is a bet that it wouldn’t.
As long as there are markets with a depth of participants holding multiple views, a mechanism for bettors to accrue wealth based on the truth, theoretically all kinds of prediction markets should be possible. But we don’t find successful prediction markets far beyond insurance companies, stock exchanges, and options/derivative exchanges. All heavily regulated and constrained. Why is there hardly any success in prediction markets for say weather, sports, elections, or just any other kind of predictions?
As a good rule of thumb, proprietary technology must be at least 10 times better than its closest substitute in some important dimension to lead to a real monopolistic advantage.
- Peter Thiel (in “Zero to One”)
Honestly, sports betting or election betting doesn’t improve by 10x when it moves from WhatsApp groups or discord forums to an online centralized platform. In some ways it has downsides for e.g. many geographies ban certain kinds of betting and users might be penalized if their identity is revealed. The payment to the online platform can be blocked by banking partner(s). Then some bets are heavily regulated and might not be allowed to happen on any prediction market/exchange. In fact, the reason for the downfall of Intrade, the most popular prediction market exchange of the time, was a regulatory ban stopping them from participating in US-based financial options/ future predictions.
Regulation is a barrier and limits the number of markets. Reliance on banks is another issue, as customers need the bank’s permission to transfer the money to the prediction market exchange. Users can be penalized in geographies where certain kinds of betting are banned by finding their real-world identities. Prediction market exchanges also have custody risk in that customer’s money needs to be deposited with the exchange and exchanges can run away with the same. On top of it, the prediction market also suffers from Oracle risk, in that they can be unreliable and may take sides of the position that benefits it.
If only we could remove these barriers, for every barrier removed, a cascade of users may throng to try a prediction market exchange, turning the tide of network effects to run down the regulatory requirement of only doing permission-ed innovation in this space.
There are so many things Bitcoin adherents claim can be fixed by Bitcoin, that there’s even a meme for it “Bitcoin fixes this”. Is prediction market one of them?
TL;DR: YES!
Bitcoin, the currency, removes the problem of having to rely on banks and requiring a user profile to move money between the two parties holding opposing positions in the prediction market exchange. DLCs can work on base-layer, side-layer like Liquid, or even layer 2 solutions like Lightning Network.
DLCs on Lightning Network are super cheap, instant, and quite an amazing invention. (Bonus fact: Tadge Dryja is a co-inventor of Lightning Network as well as Discrete Log Contracts)
Smart contracts solve the problem of custody risk in that customers don’t need to deposit money to a third party or rely on a third party to adjudge the bet. Ethereum contracts and the conditional payment functionality that bitcoin opcodes can unlock two or more parties to enter into a contract without having to deposit the money to a third party for arbitration. The conditional payment functionality is what makes Lightning Network possible. DLCs extend the Lightning Network and make payments conditional on external information, outside of the blockchain.
A self-executing contract based on predefined external condition(s) can make the collusion between bettors and oracles an even more acute problem because public addresses are pseudonymous. The way DLCs mitigate this oracle risk is by allowing bettors to choose an oracle(s) of their choice, but oracle(s) can never know of the contracts making use of their information.
A bitcoin node cannot censor a transaction deemed illegal by a regulator thereby making Bitcoin transactions uncensorable. Similarly, a lightning node cannot censor any kind of DLC for all DLC transactions that look similar to LN transactions and cannot be censored making prediction markets outside the reach of regulators.
Regulators can still censor platforms that help in aggregating the users who would like to take positions on both sides of DLC if it’s happening on a website or app.
When you can avail an oracle’s data by paying a few satoshis why would you hold a token for that? Seems like bad news for Oracle tokens like Chainlink, Band, etc.
We will explore the technical side and how they work in the next part of our DLC series.
