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Academy > Crypto Insights > What Are Prediction Markets: Explained For Beginners >

What Are Prediction Markets: Explained For Beginners

2022-09-07 09:17:14

Summary

  • A prediction market is where people can place bets on binary outcomes of future events, from presidential elections to entertainment award wins, sports matches and asset prices, including crypto price predictions.
  • Traditional prediction market players are poised to be disrupted by blockchain-based competitors who can offer cheaper fees, more transparent processes and faster payoff distribution.
  • Phemex is the first centralized crypto exchange to host a prediction market on its platform for a one-stop, seamless user experience.

prediction markets

What Are Prediction Markets?

A prediction market, also known as a betting market, is where people bet money on future outcomes. These outcomes are usually binary i.e. yes or no. If they choose the outcome that comes to pass, they win money.

Prediction markets have been around since ancient civilization. Nowadays, prediction markets span politics, entertainment, sports, stock prices, crypto prices–anything under the sun, in fact. Examples of markets can be:

  • Will the price of a barrel of crude oil be $90 or more on September 15, 2022? Outcomes would be YES or NO.
  • Will NATO expand in 2022? Outcomes would be YES or NO.
  • Will Rafael Nadal win the 2022 US Open? Outcomes would be YES or NO.
  • Will ETH 2.0 Merge fail? Outcomes would be YES or NO.

The big deal about prediction markets is that they have been shown to consistently outperform traditional prediction models such as expert panels, analyst opinions and public polling. A famous example is The Iowa Electronic Market, a not-for-profit organization run by the University of Iowa, which has predicted the results of presidential elections with more accuracy than many traditional polling outlets.

According to a Harvard Business Review article, the combination of multiple, independent judgments i.e. the wisdom of crowds is often more accurate than even an expert’s individual judgment. The premise is that people make better, more informed forecasts when they have to put money on it. 

Another well-known prediction market platform, PredictIt (also an academic research unit), has become a trusted, invaluable source of information for journalists and the public about political outcomes. It was one of the few sources to first forecast the possibility that Donald Trump would run for president, back when many did not think it was likely at all.

Scale is a critical factor in the accuracy of prediction market outcomes; the more individuals participate in the market, the more data there is, and the more accurate it becomes.

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How Does a Prediction Market Work?

Just like exchanges, prediction markets trade assets–except it’s not stocks or crypto being traded, but outcomes. These assets trade between 0% and 100%, represented by $0 to $1.  The current market price represents the majority voice of the traders.

The prize pool is the sum total of the funds committed to both outcomes. Traders buy shares in the prize pool – the more shares they buy, the greater the percentage of the pool they own.

When a forecasted event occurs, traders who purchased shares of the correct outcome are paid $1 for each share that they owned; all of the shares of people that choose the wrong prediction will be distributed to them.

Let’s use a real on-going example with a Bitcoin price prediction market run by Polymarket, a decentralized prediction market, to make it clearer. Notice that the market price is $0.96 for “no” with the remaining $0.04 making up the “yes” i.e. “no” is the crowd consensus and the likelier outcome.

prediction markets explained

As can be seen, the crowd consensus is that Bitcoin will not reach its all-time high in 2022, making “no” a safer bet with a maximum ROI of 3.19% and “yes” a riskier bet with a maximum ROI of 1,829%. So even in prediction markets, the usual investing principle applies–the higher the risk, the higher the potential reward.

Bitcoin Price Predictions Markets

Bitcoin price prediction markets bet on the expected future price of Bitcoin, and are among the most popular. As it is still the dominant cryptocurrency, Bitcoin prediction markets can also be used as a proxy of market sentiment for future crypto market trends. Many prediction platforms nowadays will have at least one market on Bitcoin price predictions (as seen in the example above) at any given time.

Benefits of Prediction Markets: Not Just Good for Betting

Prediction markets can support the growth of healthy, functioning societies. The more accurate the forecasting data, the better decisions governments, institutions and companies can make, be it in terms of sound public policy planning, governance or creating products and services in line with societal values like sustainability and ethics.

Prediction markets can even help counter the proliferation of fake news. Former Coinbase CTO Balaji Srinivasan once tweeted:

“Blockchain-based prediction markets may be the one force strong enough to counterbalance the spread of incorrect information on social media. They give people a financial incentive to seek the truth and then protect them with the twin shields of pseudonymity and decentralization.”

What Are Crypto Prediction Markets?

As the blockchain and Web3 industry matures, cryptocurrency continues to find new applications. Just as there are traditional stock exchanges and crypto exchanges, there are also traditional prediction markets (which have been around for decades) and crypto prediction markets.

Traditional prediction markets like PredictIt and Kalshi use US dollars for the trading of outcomes and distribution of profits. Crypto prediction markets, also known as blockchain-based prediction markets, use crypto such as the stablecoin USDC to trade with.

In addition, while traditional prediction markets are managed by a central operator, trades in crypto prediction markets are self-executed via smart contracts to distribute payoffs.

Cryptos and blockchain technology may just be the game-changers in prediction markets–transactions will be faster, more secure and cheaper. Most importantly, crypto prediction markets are also fairer and more transparent, as players will not be banned for winning too much and too often (as is often the case with traditional prediction markets.)

List of Decentralized Prediction Markets

Some of the well-known decentralized prediction markets include:

  • Polymarket: Built on the Ethereum network with Polygon technology, it enables users to make predictions on various real-world events using crypto
  • Omen.eth: a platform that gives anyone the ability to create a prediction market for topics spanning crypto, sports, politics, entertainment and more
  • PlotX: a cross-chain prediction market protocol that enables crypto traders to make crypto-asset price predictions in various time frames (hourly/daily/weekly)

However, centralized crypto exchanges are also getting into the prediction markets space  in order to provide a one-stop financial services platform spanning crypto trading, savings, and now, informed betting.

The World’s First CEX-Hosted Crypto Prediction Markets

Phemex recently became the industry’s first centralized exchange (CEX) to launch a prediction market, where users can trade outcomes using crypto.

an example of prediction markets in crypto

The Phemex Prediction Markets will not only focus on crypto market predictions; just like other existing prediction markets, it will enable users to make predictions on topics including entertainment, news, politics, sports and financial market prices, among others.

With the Phemex Prediction Markets, users can now:

Enjoy a one-stop, cost-effective experience

When a user correctly predicts an outcome, he can channel some of the profits into high-yield Phemex Earn APY accounts, and use another portion for leveraged trading on the Phemex Contract Trading platform. Not only does this save time, it saves money, as a user no longer has to bother transferring his crypto from one exchange or platform to another, which incurs network transaction fees and exchange withdrawal fees each time.

Offset investing/trading risks

Users can now “hedge” crypto price movements by betting on the outcome of real-world events. For example, you can go long ETH on Phemex in anticipation of a successful Merge update, but “hedge” it by betting that the Merge will fail on the Phemex Prediction Market.


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