Search for the most disruptive technology of the present times and you will come across the term called blockchain. The uses of blockchain and externalities on different sectors of the economy are still under question. One of the most important and niche areas which can be strongly affected by this technology is the forecasting or prediction markets. To analyze the case, we need to first establish a few basic concepts which make the technology unique. Blockchain is a secured and immutable chain of blocks that can store information. The chain works on the peer to peer network wherein every computer in the network can see the information. This makes it transparent. Transactions that are made must be approved by everyone in the network making it decentralized eliminating the need for intermediaries. Each block carries some data and a hash of the data in the previous block. Simply put, hashing is a method of cryptography that gives a fixed length of output irrespective of the input. A small change in the input brings about a significant change in the output. Because of this feature, it is practically impossible for anyone to attack a block and change the data. Changes had to be done in the complete chain as they are interlinked by a hash pointer. This makes the technology secure and immutable.
Having established the necessary understanding of the technology, we can now explore prediction markets. Consider an event that is expected to occur sometime in the future. One can predict that the event will occur, and one can also disagree. If we get into a contract that binds us to pay a certain sum of money if the event occurs, the value of the contract will keep on changing depending upon the probability of the event occurring considering the changing environment. We will be in profit if we can correctly predict the occurrence of the event. This is the core of prediction markets. At first, this may sound like gambling but let me assure you that there is a lot more to it and we are going to explore it all. The first key difference is knowledge. When a person predicts or guesses something, it is normally based on limited information. You would agree that the prediction becomes more correct as we gather more information on the subject matter or seek expert opinion on the matter. Instances of investors benefiting from insider information are not new to us.
Current prediction markets make use of this “wisdom of the crowd” and predict outcomes that prove to be more accurate than any expert. The basic behind it is quite simple. Imagine a large sample of participants trying to predict an outcome. Their probability of the mean of the observations being closer to the actual result is very high unless the predictions are totally nonsensible. Larger the number of observations, more accurate is the result. Presently prediction markets are controlled by intermediaries or platforms hosting such predictions. There have been websites that hosted many predictions and they proved to be quite accurate. The whole concept goes for a toss given the possibility of these agents manipulating the results for their benefit. When people start predicting the outcome of important future events, there is a distribution of power. Some institutions in the real world can find it really disturbing. That’s why some of these platforms were banned. This is where the blockchain technology can play a pivotal role. As we discussed earlier the decentralization characteristic, the use of blockchain can eliminate these players and make it truly a crowd knowledge-driven phenomenon.
The use of blockchain eliminates powerful third parties and the use of a centralized server. As the transaction is stored in different blocks in the normal blockchain, the bets are also stored in the form of smart contracts. The data is also better protected from any kind of corruption. The identity of users is also protected which incentivizes them to share the real opinion. Users in the network can buy others’ bets and the price keeps on fluctuating in the same way as it does for a futures contract. One thing to notice here is the interaction between the blockchain and the real world. We are dealing with the questions and issues of the real world and trying to predict the outcome in the virtual setup. The important part of the process is the closure of the contract. It is very critical to transfer the information from the real world about the result of the prediction. Oracle does this job for us. There can be two types of questions. One can be of binary type where we are just expecting a simple answer which can be verified from some websites. These can be predicting the result of the election, the market cap of the company or production of a crop. The other type of question may require us to analyze the situation in detail and come up with an answer. This type of task cannot be done with sophisticated robots. Analysts must have a human intervention to improve the efficiency of the system in these cases.
Predictive markets can prove useful in many fields ranging from science, economics, sports, politics. There are questions to be answered in every sector and blockchain can extract the true potential of predictive markets because of its unique characteristics.