Decentralized prediction markets are a fascinating sector of the blockchain space that has yet to truly achieve their full potential in terms of adoption by the traditional economy.
Many people who trade futures and options today are unaware that these financial products were initially invented to enable businesses to hedge against external risks that could affect their bottom line.
A classic example of this is a Corn farmer who uses futures contracts or options to bet on the price of Corn going down as a way to hedge against the loss of revenue they would face if such an event occurred. Similarly, airlines use futures contracts or options to bet on the price of oil going up as a way to offset rising fuel costs.
Decentralized prediction markets are a natural extension of this practice that can potentially give real-world businesses greater flexibility and transparency in their hedging strategies.
Yet due to poor liquidity, security risks, and the lack of a robust identity system, the traditional business world has yet to embrace decentralized prediction markets.
How Decentralized Prediction Markets Work Today
Augur and Gnosis are two of the most popular projects to bring prediction markets to the blockchain using smart contracts and data oracles. On these platforms, users can create their own predictions and stake tokens as collateral in a smart contract that can go to either party depending on the outcome of the bet, as determined by oracles inputting data from the real world to inform the smart contracts of whether certain events occurred (e.g a team won a sports game, the price of an asset reached a specific target, it rained in a particular city, etc).
The odds and subsequent payout of a bet are priced by the market based on the supply and demand of prediction shares or ‘outcome tokens’, with each share/token representing one side of the bet. The collateral staked by betters is what is used to produce more outcome tokens, which at the end of the event can be redeemed for the collateral in the pool depending on the final outcome.
- For example, if the prediction is that it will rain in New York on February 3rd 2022, the outcomes would be Yes or No, and the outcome tokens could be $YES and $NO.
- To place a bet, users would normally have to place DAI or ETH into a pool as collateral in order to receive YES or NO tokens.
- These tokens will each have a price that will fluctuate based on supply and demand as people speculate on the likelihood of the event occurring.
- The price also determines the odds and potential payout
- If the market believes the YES outcome is more likely to occur than NO, more people will buy the YES tokens, causing the price of YES token to rise and NO to fall.
- If February 3rd arrives and the final outcome is that it did in fact rain, the smart contract will automatically redeem the DAI/ETH stored in the pool to all holders of YES tokens, while holders of NO tokens will receive nothing.
Challenges with Decentralized Prediction Markets
One of the biggest challenges with these prediction markets is the lack of liquidity sourcing.
Aside from popular predictions like who will be president or what the price of Bitcoin will be in 2024, most predictions struggle to generate enough collateral on either side for large players to participate and significant gains to be won.
This challenge is primarily due to the lack of interoperability between blockchains, which prevents players across disparate prediction markets from connecting and forming larger more liquid markets.
Other challenges preventing larger players from joining include lack of transparency around who is on the other side of the bet (does the person have one identity or multiple pseudonymous identities) and smart contract security (how is the outcome enforced in the event that the smart contract is hacked).
Accumulate ADI’s Improve Liquidity Sourcing
As we’ve mentioned in previous articles, Accumulate Digital Identifiers (ADI) enables the Accumulate network to serve as the de-facto communication and audit layer between blockchains. Tokens or other kinds of digital assets can be seamlessly transferred between digital identities across different chains regardless of their consensus mechanism.
Through Accumulate’s ADI solution and interoperability capabilities, it becomes much easier for players to create markets without having to incur the risk of moving large amounts of capital to different blockchains. This leads to more efficient sourcing and consolidation of cross-chain liquidity for new prediction markets.
Furthermore, establishing a cross-chain prediction market would allow new capital to flow in from Ethereum, Solana, Cosmos, and other ecosystems, encouraging participants to take the other side of more niche predictions.
The more liquidity exists in prediction markets, the more accurate the pricing of new bets, and the more markets can be created around very specific predictions, which gives greater opportunity for enterprises to hedge against uncertainty in a more direct way.
Enterprise Adoption of Prediction Markets
Accumulate can help bring prediction markets to the enterprise world by establishing a secure communication and audit layer for companies to create and participate in prediction markets with other verified entities while gaining access to cross-chain liquidity sourced from the entire DeFi ecosystem.
ADIs also enable greater forms of accountability for market participants, making it more difficult for betters to game the system by hiding behind multiple pseudonymous public key addresses or deploying bots to frontrun bets.
Securing Prediction Market Outcomes
Accumulate enables greater security of prediction market outcomes by fortifying its network data through a solution called ‘Anchoring’.
Anchoring works by inserting a cryptographic proof of a batch of transactions into another Layer 1 blockchain like Bitcoin or Ethereum. This is the equivalent of backing up your data on multiple hard drives that each have their own unique security system.
Anchoring allows the Accumulate network to essentially buy the security of a larger and more secure blockchain for the cost of a single transaction, enabling all prediction market outcomes and other recorded transactions on the Accumulate Network to be backed up on multiple decentralized networks.
Improving Trust Amongst Oracles
Using ADI’s, Accumulate can also establish a more trusted network of oracles by assigning ADI’s to data providers and creating a reputation-based system.
Accumulate can also leverage sub-identities as a way to catalog prediction market types (e.g sports, weather, prices, etc) and also catalog the history of final results for prior markets. This would enable more accurate and transparent classification of data points that can help improve the calculation of odds and create more informed and efficient prediction markets.
Introducing decentralized prediction markets to real-world companies through the Accumulate Network could enable enterprises to develop more precise hedging strategies while incurring lower costs to insure against negative outcomes.
For example, airlines could hedge against flight delays by creating region-specific prediction markets around weather, traffic jams, etc. Manufacturing companies could also create prediction markets to get more favorable insurance coverage for shipments coming from regions where traditional insurance companies may charge a high premium due to geopolitical uncertainty.
Prediction markets still have a long way to go before becoming widely used by traditional companies to hedge against business risks.
With Accumulate decentralized identity and anchoring solutions, we could begin to see this sector reach new levels of adoption through improvements in liquidity, security, transparency, and interoperability.