Blockchain use case: prediction markets
When we happen to see the terms blockchain and marketplace in the same sentence, we undoubtedly think of the ecosystem of trading platforms that facilitates the flourishing of cryptocurrency trading. Blockchain technology is extremely versatile and is the foundation upon which all types of markets are built.
Financial assets are either tangible physical objects or intangible digital products. Regardless of the type of asset, as long as there is value in holding it, there is bound to be a potential market for it.
In this article, we take a look at a particular market that significantly benefits from blockchain technology, the prediction market.
What are Prediction Markets?
Prediction markets are speculative markets where market participants do not trade options or cryptocurrencies, but rather information. To be precise, investors bet on the outcome of future events.
There are all sorts of events that can be bet on, provided that the broker is willing to include them in the sales list. Let’s take the example of a question with a “yes” or “no” outcome: will there be a railroad line between the United States and Europe by 2025?
There are two potential outcomes to this event. Either “yes” or “no”. If we are confident that there will be no train traffic in five years, then we can purchase a series of no contracts. Each contract is priced from 0 to 1 dollar.
If the train does not run by the deadline, the no contract is cashed out for $1 and the yes contract is worthless. Conversely, if the train does run by the deadline, the no contract will be worthless and the yes contract is worth $1.
At the same time, the value of the contract will fluctuate as market sentiment changes and new information emerges in the market. As an example, the price of the no contract could rise if the deadline approaches and no progress is made on the underwater tunneling technology. If a large company announces that it plans to launch the train service in 2024, the price of the yes contract will rise.
This appears to be a typical speculative market. Participants buy contracts and expect their value to increase over time. But prediction markets are much more than what we think of as ordinary speculative platforms. If used correctly, prediction markets can be powerful forecasting tools.
Why Prediction Markets Work
When making a bet, market participants are likely to have information that influences the decision. Unlike a regular bet, some of the external factors affect the probability of a particular outcome.
Wise investors do their own research, while experts weigh the pros and cons. People with inside information or familiarity with the subject matter will invest in contracts that they believe have the potential for appreciation. In short, prediction markets are information aggregators.
In the Intercontinental Train example above, if the NO contract is trading at $0.90 and the YES contract is trading at $0.10, this means that only a few people are confident in the success of this prediction. The collective insight of the market is reflected in the data as those with information are financially rewarded for “reporting” what they know.
Prediction markets excel at collecting and presenting information based on the principle that the wisdom of the group is usually superior to the data held by a few experts. Market research has found that stakeholders from a wide range of industries, whether from IT or renewable energy, can benefit from knowing what ecosystem trends are predicted for their industry. Not only that, but the market is able to accurately outline future trends through crowdsourced information.
Proponents even suggest that prediction markets could become the core technology of a new form of democracy called “Futarchy”.
Instead of yes-or-no contracts, we can bet on, for example, a presidential election using mutually exclusive outcomes. Suppose candidate A and candidate B are running for president. A bettor who thinks candidate A will win buys a contract on candidate A, while a supporter of candidate B does the opposite.
Prediction Markets and Blockchain Technology
Prediction markets are highly likely to be powerful tools whose value proposition is greatly enhanced if made decentralized. Current centralized platforms offer limited services, either because they are restricted by local laws and regulations or because the owners are unwilling to list certain contracts.
Moreover, users have to trust the operators of such platforms and pay additional fees for using their services.
The traditional centralized model will be replaced by a decentralized approach based on blockchain. This will bring a number of benefits, such as resistance to censorship, cutting down on the number of intermediaries and improving accessibility.
Censorship resistance
Existing prediction markets are usually operated by a single party. This means that entities such as government authorities or unscrupulous individuals can easily shut them down. However, decentralized platforms are not as easy to bring down.
With smart contracts involved in governance, single points of failure will no longer exist. Every node in the network can run code. If a contract is created in a certain way, no user will be able to edit or delete the program that underpins that market.
No intermediaries
Blockchains don’t need administrators. Outsourced automated code replaces the work of traditional third parties, so there is no longer a need for intermediaries. Users interact directly with smart contracts, meaning there is no need to pay a third party (i.e., a centralized platform). Since users don’t have to trust anyone, this eliminates some of the counterparty risk.
No License Required
With decentralized prediction markets, individuals are free to bet or create contracts whenever and wherever they want. The geographical or regulatory restrictions that previously plagued the platform will no longer exist.
Functions of the Blockchain Prophecy Machine
How can we be sure what the outcome will be at expiration if there is no broker or centralized institution of any kind?
We need some sort of “truth” mechanism, and this is where the Blockchain Predictor comes into play. We want to utilize a data feed to tell us exactly whether or not the outcome is going to happen. Here are a few possible ways to accomplish this.
The easiest way is to access a third-party website or data stream, which fundamentally undermines the use of the blockchain. After all, the results will be controlled by a third party, who could potentially lie for personal gain or become a target for attempted cheaters to pull the wool over their eyes.
Another option is to utilize financial rewards to encourage users to report incidents truthfully. To implement a pledge mechanism, users would need to pledge tokens to make a report. If the report is true, the user receives some form of payment. If an attempt is made to falsify, they will lose the pledged tokens.
The use of a blockchain prediction machine in a prediction market is kind of an innovative concept.
Being an emerging technology, we are yet to determine which type of prediction machine is suitable for different types of prediction markets.
To summarize
Prediction markets are not only effective in betting on future outcomes, but they are also an advanced means of gathering all reliable information. By utilizing economic incentives for individuals to share the information they have about the market, we can gain insight into trends at the social, industry, and political levels.
For now, the shortcomings of centralized platforms prevent prediction markets from reaching their true potential. However, as soon as decentralized solutions take their place, the situation is about to be reversed. As prediction machines become more powerful, blockchain technology will be able to store certifiably fair codes that cannot be tampered with.
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