Prediction Market: Using financial means to foresee the future

A prediction market is an open market that uses financial incentive mechanisms to predict the outcomes of specific events. These markets allow traders to place bets on the possible outcomes of various events. Market prices can reflect the overall judgment of the public regarding the probability of the event occurring.

The typical trading range for prediction market contracts is between 0% and 100%. The most common form is the binary options market, where the price at expiration is either 0% or 100%. Users can also sell options at market price to exit before the event occurs.

Through prediction markets, we can extract the public's expectations about the future outcomes of an event from the value judgments of the betting participants regarding that event. Traders with differing views express their confidence in possible outcomes by buying and selling contracts, and the market prices of these contracts are seen as the aggregated consensus.

Prediction markets have a long history, almost as long as the history of human gambling. The combination of prediction markets and politics also seems to have a long history: in the Middle Ages, people were keen to predict and place bets on the outcomes of papal elections.

As the U.S. presidential election approaches, interest in political-related bets reached a new peak in July with a series of events, and prediction markets represented by a certain prediction platform have garnered widespread attention.

Several Typical Prediction Market Platforms

A tradable prediction market on a certain order book

This is a decentralized prediction market project that was born in 2020, founded by someone and supported by several well-known institutions and angel investors.

The platform allows users to trade on highly controversial topics in the world ( such as politics, sports, and popular culture ), enabling users to build their investment portfolios based on their predictions.

Unlike traditional sports betting, this platform allows users to freely trade shares on market topics that have not yet reached a conclusion, enabling speculators to flexibly participate in probability games.

The platform uses a conditional token framework, where for every 1 dollar of stablecoin collateral invested, two conditional tokens are generated, representing the positive and negative outcomes of the event, respectively. A multi-outcome market is a comprehensive statistic of multiple binary outcome markets.

Conditional tokens fluctuate in the market due to trading demand, and users can buy and sell at any time through the order book; they can also wait until the event has a result, and those holding the correct token will receive the entire $1 profit.

Because the two tokens trade independently, there may be a situation where the sum of the prices of the two tokens does not equal 1 dollar, which requires market makers to participate in arbitrage. Before the event ends, one can also use one token in a positive direction and one in a negative direction to exchange back for 1 dollar worth of collateral in the contract.

The prediction market of the platform mainly includes the following parts:

• Market Theme: Each prediction focuses on a specific theme or event, and the platform has discretion over which markets are created.

• Oracle: The determination of event outcomes usually requires human input. This platform uses a certain optimistic oracle that allows anyone to submit solutions.

• Conditional Tokens: Lock 1 dollar to obtain two conditional tokens "Yes" and "No". At settlement, the person holding the correct result receives the entire 1 dollar.

• Order Book Market: Adopts a hybrid on-chain order book trading mechanism, similar to a certain decentralized exchange.

• Liquidity providers: Anyone can place limit orders to earn the price difference, and the platform also provides additional incentives.

The platform currently does not have a clear token issuance plan, nor does it have an active incentive points program for users. However, this year it has distributed over 3 million USD in stablecoins through a liquidity rewards program to incentivize market-making activities. Currently, the market with the highest trading volume pays liquidity providers approximately 600 USD in rewards daily.

A Single Bet Prediction Market

This is a sports betting platform established in 2019, currently relying on a certain Layer 2 network.

The betting markets currently supported by the platform are primarily focused on sports, with winner bets surrounding major events such as tennis, football, baseball, and basketball. Recently, cryptocurrency and political-related topics have also been added.

Unlike the aforementioned platforms, this platform follows the traditional sports betting model, supporting only single bets, and does not allow free trading of bets until the outcome of the predicted event is determined.

The innovation of this platform lies in the realization of a combination betting system for the first time, where users make predictions on a series of events and can only win a prize if all are correct. The returns from combination betting are often very substantial and can be seen as leverage in the prediction market. The platform will act as the counterparty.

This type of combination betting is more like a lottery and can bring returns of up to tens of thousands of times. Successful cases can easily go viral, which is also the most interesting aspect of traditional sports prediction markets.

It is clear that prediction markets based on a "dual-token" conditional framework cannot achieve composite betting, as it is impossible for the contract to issue a conditional token for every possible outcome combination and ensure that it can be freely traded under sufficient liquidity. Prediction markets with only two outcomes have limited odds, which may not be attractive enough to users.

An AI-driven topic prediction market

This is an initial prediction market based on a certain blockchain, covering various topics such as politics, cryptocurrency price predictions, popular events, and more. It currently supports betting with stablecoins on multiple blockchains and has launched a corresponding Telegram mini-program. This mini-program provides users with two modes: one is a game mode where users earn points by predicting the probability of hot events; the other is a real mode where users can link their wallets to participate in bets on similar topics on the official website.

Unlike the prediction topics proposed by users on the aforementioned platform, the prediction topics on this platform are mostly generated by AI, which grabs popular news and market sentiment indices from the internet and automatically pushes them to the website, where users spontaneously form a trading market. Although it supports multiple blockchains, it is not a fully decentralized application. The prices corresponding to the different outcomes of various prediction topics are determined by the platform's centralized order book, while the order placement process and the market for each prediction topic are implemented according to smart contract rules.

Objectively speaking, the platform is still not mature compared to other prediction markets. The order book depth of predictable topics and betting transaction volume on the website are far lower than those of other platforms. As a prediction market, it should allow users to freely trade tokens of different outcomes before the events are revealed. However, the platform's order book does not support users placing orders themselves. In the absence of market makers in most markets, users are actually unable to freely trade outcome tokens. Furthermore, the documentation does not detail how to ensure the consistency of market contracts for topics across different chains when implementing multi-chain betting support, as well as how to guarantee sufficient liquidity for all outcome tokens across each chain. In the "real mode" of the mini-program when connecting the wallet for trading, there are discrepancies between the betting prices of the prediction market for the same topic and the prices on the official website.

Various circumstances have raised doubts about the practical usability and reliability of the platform. Overall, this product currently resembles a work in progress.

A Betting Protocol Supported by Liquidity Pools

This is not the prediction market itself, but rather a foundational protocol for creating on-chain prediction markets. This entire set of permissionless infrastructure includes on-chain smart contracts and web components, which can be used to establish multiple prediction market applications.

This protocol can only make a single bet and cannot freely trade between "yes" and "no" like some platforms; profits can only be obtained after the results are announced.

The system is built around liquidity pools as the core, allowing anyone to deploy their own liquidity pool by interacting with the factory contract. Multiple betting platforms can be created under a liquidity pool, and for each betting platform, multiple possible events can be established for different prediction topics, allowing separate bets.

Under the binary split model, liquidity is isolated and segmented across multiple different prediction events. The protocol proposes an idea known as the liquidity tree, which allows multiple events under a single prediction topic, and even multiple topics across different betting platforms, to share the same liquidity pool.

The liquidity tree provides a hierarchical structure, with various possible events defining the liquidity range, such as multiple score possibilities for a football match between two teams.

These liquidity funds ensure that the platform has the capability to act as a counterparty for bettors in any suitable situation, to pay potential rewards. For LP, it is a loss if bettors generally lose, then LP can earn profits. A liquidity tree provides liquidity for multiple prediction market topics at the same time and acts as a counterparty, generating profits/losses.

The odds for each event under this protocol are calculated based on the ratio of the funds bet on each event to the total liquidity of the entire prediction market. The initial odds are set by specific data providers and correspondingly add initial liquidity. Data providers can also adjust the odds during the betting process, and the solvency of these odds is guaranteed by the initial liquidity.

The protocol also supports the implementation of multiple dapp platforms, allowing betting platforms to set their own handling fees and dividends, which bettors can freely choose; while the creators of the liquidity pool can also set the dividend ratio for the pool. A certain percentage of the profits from all pools will enter the protocol's own DAO, and the protocol has also issued its own native token.

Summary

The philosophy behind prediction markets is intriguing; participants aim for profit and view the free market as the most effective system for information gathering among humans, thus making predictions about real-world events. These results are often surprisingly accurate, and in a contemporary society where recommendation algorithms monopolize information, prediction markets appear to effectively restore the truth and reflect opinions, as evidenced by predictions about political events on certain platforms.

Many cryptocurrency users may first encounter the prediction market during the last presidential election when a trading platform launched a candidate index. With strong market-making capabilities, you could even engage in fierce battles using high leverage. Although centralized, it was indeed a very interesting experience.

Of course, cryptocurrency has greatly reduced the trading friction in prediction markets, providing a better and more efficient market mechanism. Moreover, the ideas of smart contracts and AMM have also brought better market mechanisms to prediction markets—no barriers to entry and better liquidity. Many AI AgentFi projects even view prediction markets as a battleground to leverage collective intelligence and hone their capabilities.

Of course, the shortcomings are also very obvious: some platforms, although they have opened up the free trading of conditional tokens themselves, find it difficult to implement a flexible betting mechanism, lack expectations of high returns, and lose some of the enjoyment for ordinary players; while certain liquidity pool schemes are clearly still somewhat complex and lack trading capabilities after betting.

Rather than saying that the mechanism and technological innovation have led to the current popularity of prediction markets, it is more accurate to say that it is another large-scale application of crypto culture and a victory of the free market culture behind it. This is particularly valuable now that algorithmic authority gradually monopolizes information. After all, nothing is smarter than the market, and no information system is more efficient than a free market.