Why Prediction Markets are Good for Society
What is a prediction market and why they’re good for society? Here’s our in-depth analysis of the topic.
Prediction markets are a type of exchange-traded market on which forecasters can buy and sell positions that pay out based on the outcome of future events. They are closely related to insurance products, which also pay out based on an event outcome.
What are prediction markets?
Prediction markets can be created for any situation whose outcome is uncertain or contested. Prediction markets are distinct from other common techniques of crowdsourcing predictions, such as digital opinion aggregators or large-scale polls. The outcomes of elections, sporting events, and policy decisions have all been popular topics for prediction markets. Research has consistently shown that prediction markets are more accurate in forecasting the future than expert models or surveys.
PRO TIP: Rather than simply gauging online sentiment or incentivizing survey participation, prediction markets have a unique property: in order to cast a prediction, forecasters must wager real money. The more money forecasters wager, the more they are able to move the market in the direction of the outcome that they foresee.
Prediction markets have existed in varying forms for centuries. There are documented instances of widespread participation in betting markets to predict the outcomes of religious and administrative succession proceedings in 16th century Italy, for example. Still, it wasn’t until the 1940s that liberal economists first made a formal case that prediction markets provide an unparalleled source of accuracy and utility. The key point is this: when forecasters have money on the line, they try *really hard* to find the right answer.
Since then, there have been a few attempts to harness prediction markets to the full scale of their potential. Many prediction markets in recent years were only in operation for a short time before succumbing to pushback from regulators. Others placed caps on how much a single trader could wager, or was only accessible to academics or forecasters in a particular country.
Polymarket is a decentralized, global prediction markets platform that empowers forecasters to earn money by speculating on world events, enabling everyone to get a clearer picture of the future. Prediction markets are one of the most effective tools for improving how society predicts the future and, therefore, how it makes decisions. Polymarket’s mission is to promote the adoption of prediction markets to reward accuracy and repair the information ecosystem.
Prediction markets are a source of truth in a post-truth world.
The term “post-truth” gained prominence following the U.S. presidential election in 2016 and is often used as shorthand for the tendency to fashion one’s political opinions and decisions out of a highly personal mix of emotions, rumors, and paranoid superstitions, rather than reason, empirical evidence, or facts. If you were to take a somewhat longer view of U.S. electoral politics, however, you will find many instances in which voters made decisions in spite of available evidence, or out of irrational fear, electric excitement, or even profound disgust, or any of a whole slew of strong emotions stirred up by the publicity-seeking theatrics of aspiring politicians.
One thing that is relatively new to our modern age is the ability of everyday people to rapidly create, recast, and amplify political messaging, reaching massive audiences instantly through social media. Previously, it was only a highly guarded group of media professionals that were effectively the gatekeepers of public discussion through mass media like print, radio, and television.
What’s wrong with discussions that take place on social media? One issue is that because of the way algorithms and product features work on platforms like Facebook and Twitter, opinions and predictions on social media are often optimized for maximum engagement. Well-researched, thoughtful predictions shared on these platforms are often passed over in favor of other messages that, though lacking in analysis or evidence, are deliberately extreme or provocative, or reaffirm what an audience already wants to believe. What’s more, many social media platforms are riddled with bots, fake accounts, state-sponsored manipulation, and paid promotional content. Any attempt to understand the world through social media is bound to produce a pretty distorted picture of reality. Famously, the most shared story on Facebook related to the 2016 election was an article claiming the Pope had endorsed Trump. (He didn’t.)
Prediction markets on Polymarket have a leg up on even the most methodologically advanced opinion aggregators and expert models. There are two basic reasons for this. First, when people have money on the line, they aggregate all the best analyses they can find, consulting polls, models, expert commentary, and additional “x-factors” that aren’t always reflected in other gauges. The second reason is that prediction markets allow you to express not only your opinion but the magnitude of your belief. This is a crucial distinction between opinion polls, or simple thumbs up, thumbs down systems. Traders can offer their opinions, but their opinions can only move the market to the extent that they are willing to wager money on it. This allows a small group of very confident people to move the market to reflect their view, even if the majority of people believe something else, but with less confidence.
An example might be helpful here. Consider an election where a hundred people believe a particular candidate will win, but they’re not totally sure, they only have 80% certainty. Then suppose there is one person with superior knowledge who is 100% certain that this candidate will LOSE, perhaps because he’s done a proprietary analysis of early mail ballots and can see clearly that everyone else is misreading the data. In a rational free market, the person with 100% certainty will make a very large bet, and the market will move to reflect his view. In this way, if even one person has superior information, he can make a large enough bet to overcome the “bad information” guiding the majority. In a rational free market without limits, in other words, the best answer wins: the market odds will shift to reflect the view of the person with the best information.
PRO TIP: This is very different from social media, where the messages that get amplified are the most popular messages, not the most accurate ones. Here’s an example market where the prediction was highly accurate on Polymarket.
Imagine how much more representative of reality a website like Twitter would be if users were required to bet real money before they were allowed to offer opinions on what they think is going to happen in the world!
Prediction markets are unique in that they force forecasters to convert their beliefs-which are often irrational-into an action! Trades made on prediction markets are more than mere opinions, they are actionable wagers.
Prediction markets help people make more informed decisions.
Businesses, policymakers, and organizations can use the wealth of predictive insights generated by prediction markets to get an accurate view of the world and plan accordingly. Prediction markets can help policy markets predict the outcome of something as complex and multifaceted as The War in Ukraine, or predict the prevalence of extreme weather events, allowing them to allocate resources and personnel before disaster strikes.
Prediction markets can also help everyday people make personal decisions. Take covid-19, for example. Although we’re past the worst of it, the ongoing coronavirus pandemic continues to exert a profound influence over the lives of individuals. It’s likely that variants of the virus will continue to emerge and spread throughout the population at inopportune moments. When this occurs, work routines, school schedules, and travel itineraries are all subject to revision-or even, in some cases, outright cancellation. Information markets have proven to be highly accurate predictors of the magnitude of recent waves attributed to novel variants. A person planning an international trip, or even a large indoor gathering such as a wedding, would be wise to consult these numbers as they consider whether such an event will be feasible at a given future date.
Although many do not see it as such, one of the most common forms of future forecasting undertaken by the vast majority of people is budgeting. In order to create a budget, one must rely on predicted estimates of everything from their projected earnings, to the price of utilities and consumer goods. As the cost of everyday items like groceries or natural gas to heat the home continues to rise, consulting prediction markets can help consumers take a lot of the guesswork out of planning for their financial future.
Prediction markets help people hedge against negative outcomes.
Another important way that prediction markets can help ordinary people in their everyday lives is by giving people a method for hedging against negative outcomes by reducing their exposure to certain events. For example, let’s say someone has 20% of their net worth in Ethereum. The future price of Ethereum, however, will depend in large part on the timing and success of the “Ethereum merge,” when the network will execute its long-planned shift from a “proof of stake” system to a “proof of work” system, dramatically lowering gas fees. Some people worry that the Ethereum merge won’t happen for many months, or might never happen at all. If the execution of the merge is botched, it’s likely that Ethereum prices will decline significantly. For holders of Ethereum, a good way to hedge against this possible outcome is to trade on Polymarket’s Ethereum merge market. Taking a position that the merge won’t happen for many months is similar to purchasing insurance against a natural disaster: it reduces your exposure to a plunge in Ethereum driven by further delays to the merge.
Prediction markets fact-check the internet.
The internet promotes sensationalism through engagement-seeking algorithms. It can be helpful to remember that any prediction that is broadcast through the internet, whether it be on the “For You” page of TikTok or the digital opinion pages of the New York Times, serves at least two functions. It might be a sincere, good-faith representation of what one individual believes will transpire, but it also seeks to entertain, appear at the top of organic search engine results, hold the viewer’s attention, or incite them to share-all to increase the chances that a viewer will click on banner ads or purchase a monthly subscription.
Prediction markets on Polymarket only serve to facilitate trading among individuals who believe that they have the information and analysis adequate to predict future events. Moreover, prediction markets reward those who succeed in doing so. Polymarket is free from the distortions that drive so much online activity-it’s a reality check for the internet and society.
Prediction markets on Polymarket are accessible to everyone.
For many years, institutional investors have been able to trade complex derivative contracts, essentially options or insurance policies triggered by various event-based outcomes. A derivative might be set to pay out if a particular tranche of loans in a package of mortgages defaults, for example, or an insurance policy tied to particular patterns of fluctuation in currency and commodities markets. This particular maneuver, known as a credit-default swap, isn’t available to ordinary retail traders.
Retail traders are typically able to trade only one type of derivative-equity options. Options function like insurance policies that pay out when a stock hits a particular price level. This is a special type of event-based contract, and it’s one that apps like Robinhood have made accessible to virtually anyone.
Polymarket makes event-based contracts available to anyone, and it enables individuals to participate in a straightforward way with ultra-low fees and ultra-low minimum position sizes. In this way, Polymarket is a major advance in the democratization of financial markets.
Prediction markets encourage people with the best information to move the market toward their view.
Although the role of experts in public life seems to have diminished tremendously in recent years, the predictions made by trusted media figures, as well as those who occupy positions of institutional authority, continue to be the predictions that carry the most weight. Journalists and government officials might point to their advanced degrees, their years of experience in a related field, carefully calculate their rhetoric and physical presentation, or even their track record of making accurate predictions in the past, in order to establish credibility.
On Polymarket, all of these distinctions cease to matter. Friedrich Hayek once wrote that accurate predictions in various spheres are less likely to emerge through higher education or research and more likely to emerge through everyday activities that bring people into contact with factors that might influence outcomes. It is often participants who are close to the action-a digital ad salesman for example, or someone selling fertilizers on the spot market-who has their ears to the ground and are the best gauges of what’s coming down the pike.
Prediction markets encourage people from all walks of life to utilize their unique knowledge and do their own research and analysis in order to solve pressing questions. Forecasters on prediction markets are different from nearly every kind of paid analyst and professional forecaster, in that they have skin in the game. They stand to make money if the outcome is as they predicted, and to lose money if things go the other way.
Originally published at https://blog.polymarket.com on June 20, 2022.
