What is a prediction market? How they work and their uses

Prediction markets have been making headlines recently after demonstrating an uncanny ability to predict global events with a level of accuracy not even seen by traditional bookmakers or polling stations.

With leading prediction market Polymarket predicting that Joe Biden will drop out of the US presidential race, people have become increasingly interested in the ‘wisdom of the crowd’ and the potential applications of these markets.

What is a prediction market?

A prediction market is a financial marketplace where people speculate on the outcome of all sorts of events, buying and selling stocks that represent the probability of certain outcomes.

For example, the Polymarket prediction market allows users to buy and sell stocks or contracts on various events, such as political elections, sports events, music awards show results, and cryptocurrency prices, such as the possibility of Solana reaching an all-time high by the end of the year.

Polymarket is news.

Even before the debate, he priced in a 10%+ chance that Biden would drop out. Meanwhile, traditional media claimed Biden’s senility was a conspiracy theory.

No journalists, just crypto. pic.twitter.com/Vlb4sN6rgr

— Balaji (@balajis) July 21, 2024

Because these prediction markets have large numbers of skilled, methodical analysts speculating publicly on the outcomes of major events and financially incentivized to give their true opinions, they can be useful in showing public sentiment and even providing accurate predictions in some cases.

Historical background of prediction markets

Prediction markets are certainly not a new invention, dating back to at least the 1500s when people speculated on the outcome of papal elections. Wall Street has been betting on political elections since at least the 1800s, and there is evidence of prediction markets betting on elections in Canada and Britain during the same time period.

However, in modern times the nature of these markets has become significantly more complex and advanced.

Let’s take a look at how these prediction markets work.

How do prediction markets work?

Typically, a prediction market allows users to buy a contract or stock that represents an outcome. A market will have a specific set of events with two or more outcomes that users can trade on.

For example, a market may speculate on the outcome of an election that has two possible outcomes. It will open with contracts available to purchase supporting a victory for either candidate, and these stocks may begin trading at equal values.

So Candidate A’s victory will have a number of contracts priced at, say, $0.50, and Candidate B’s victory will have the same amount of contracts priced at the same price.

As users begin trading contracts, the value will fluctuate in one direction or the other, indicating the general sentiment of the crowd speculating on the event and giving viewers an idea of ​​what the market thinks will happen.

Polymarket shows the possibilities of US TikTok ban with contract stock prices | Polymarket

Unlike a traditional bookmaker that gives odds on such events, users in a prediction market can trade contracts at specific points throughout the event’s lifecycle, making a profit or preventing losses.

In crypto, these markets typically use a hybrid decentralized model. While the platform’s staff still decides which events to trade, the community itself can provide liquidity to the market and attempt to make a profit by doing so.

We have written a comprehensive guide to the Polymarket prediction market, including the nature of making profits by providing liquidity.

Types of prediction markets

There are four main types of prediction markets in 2024. While the list below refers to general types of platforms, we will examine specific types of betting models further down.

Fixed Odds Betting

Fixed odds betting is the type of market most people are familiar with, the odds set on an event by a traditional bookmaker or sports betting website. Users place bets and cannot trade or sell their contracts and the payout is calculated based on when users place their bets.

Continuous Double Auction (CDA)

CDA markets allow users to buy and sell orders at any time and allow arbitrage and swing trading of contracts until the end of the event. Polymarket is one such market as Iowa Electronic Markets uses fiat instead of crypto.

Automated Market Maker (AMM)

AMMs like Augur and Gnosis use algorithms to provide liquidity and automatically set prices based on supply and demand for contracts. They are more decentralized than crypto prediction markets like Polymarket, which have more human oversight and can be considered hybrid-decentralized or perhaps just centralized.

Parimutual Markets

Parimutuel markets, like the Hollywood Stock Exchange, pool bets and calculate payout odds based on the spread of bets across different outcomes. Winners split the final winnings pool.

Types of contracts/bets available in prediction markets

There are several ways a contract can be played in a prediction market, or to put it more simply, there are different betting models available.

Binary yes/no results

A binary market is the simplest type of market or contract in the prediction market.

Categorical markets

Categorical markets have multiple possible outcomes rather than a simple yes or no, allowing for a wider variety of trading options.

Scalar markets

Scalar markets, or scalar betting, offer continuous outcomes within a range. For example, a market could trade on the price of Bitcoin through the end of the year, with options ranging from $20,000 to $10,000. Instead of having multiple fixed options, users can buy contracts based on their guesses of the correct answer, and the closer they are to the truth when selling their contracts, the more valuable their contracts become.

Best crypto prediction markets 2024 and beyond

Now that we know how crypto prediction markets work, let’s explore some of the best crypto prediction markets currently available.

It is worth noting that crypto prediction markets are a relatively new addition to the ecosystem and none of the markets below currently offer advanced trading features such as stop-loss or take-profit automation.

Very market

Polymarket is a crypto prediction market built on both Ethereum and Polygon blockchain networks and interfaces with Web2. Users trade contracts in USDC stablecoins. Polymarket is now the top crypto prediction market by trading volume.

Prophecy

Augur is a completely decentralized prediction market on the Ethereum marketplace. Augur operates programmatically, meaning there is little to no human oversight. Smart contracts read oracles, which are autonomous tools that feed news and market information to contracts to determine the outcome of an event and pay out profits.

Spirit of the times

Zeitgeist is a prediction market built on the Kusama network. Users can take advantage of a variety of betting models and the market is decentralized. Like Augur, the platform uses real-time oracles to feed live data to pre-programmed smart contracts.

Will crypto prediction markets price in?

Crypto prediction markets have been flying under the radar for some time now, often allowing a select niche community to benefit from the so-called ‘wisdom of the crowd’.

However, the recent intense publicity around prediction markets is largely due to Polymarket’s cautious election campaign predictions, and the landscape is undergoing major changes, with mainstream investments and high trading volumes now coming to the fore.

It will be interesting to see if prediction markets become a more common indicator for predicting crypto prices in retail and institutional markets. If so, whether they suffer from being priced in, meaning that prediction markets can influence actual crypto prices, which could lead to predictions being inaccurate as the market adjusts to them in real time.

Either way, the accuracy that prediction markets sometimes display is astounding, and these markets are likely to become a key indicator for strategists and investors around the world.