A butterfly flaps its wings in New Mexico and causes a hurricane in China. Chaos theory isn’t terribly difficult to grasp: a small, seemingly-insignificant events can, if not cause, then at least correlate with larger, actually-significant events happening here in the world. No matter how hard we may try, some events; the weather, for example, remain frustratingly unpredictable because we have a hard time, metaphorically speaking, accounting for all the butterflies flapping their wings all over the world. But what if we could?
Enter prediction markets.
Decentralized Prediction Markets (DPM’s) hold the potential to revolutionize the way people think about information and investment by incorporating Big Data with Financial Markets in a way that’s accessible to the whole world. A DPM works like any other stock or commodity (or cryptocurrency!) exchange but instead of only being able to bet on whatever financial products the exchange offers, users can create their own unique way of betting on the outcome of any event they propose.
How Do They Work?
Prediction markets create incentives for individuals to share their thoughts on the outcome of any given event. Events can be measured in three ways:
- Binary: An event occurs or does not occur (ex. A coin lands heads or tails).
- Categorical: One of a given number of possibilities occurs (ex. Voting results in the election of one out of several candidates).
- Scalar: The results of an event rely on upper and lower bounds (ex. The point spread of a basketball game).
Traditional investment involves a investors looking for the best return on their money and organizations offering certain financial products to essentially bet on. Hypothetically, the more value a business contributes to the world the more money investors should be willing to throw at it because creating that value should provide the largest return on their investment. Things don’t always work that way in the real world for a variety of reasons, mostly due to regulatory capture. Good investment involves being able to make the most educated guess you can about whether or not something will be important in the future.
DPM’s turn the system on its head by allowing investors to create their own products based on any kind of outcome they can dream up. By allowing people to bet directly on events we can generate much more valuable information than we currently receive by watching the trade of stocks, commodities, or other financial instruments. Companies already rake in billions on Big Data by spying on your spending, savings, and search history and passing that off as information to help other businesses find better ways to serve you, but imagine if you could cut out the middle man and make money by sharing what you really think with those in a position to do something about it?
Why Do They Work?
The economic theory behind prediction markets stems from Mises’ Economic Calculation In The Socialist Commonwealth and Hayek’s The Use of Knowledge In Society, which draws a parallel between people’s desires as the lense through which they judge their transactions and the free exchange of information that leads to efficient markets. You desire food more than toys so you allocate money to food first, just as investors know that people will always need food, so there will always be investments to be made in food.
The ability to bet on anything creates uncomfortable possibilities: markets speculating when and how celebrities will die, for example, but one could argue that the popularity of these markets merely reflects society’s interests and forces us to take a more critical look at the things we’re actually investing in. Anyone can invest in oil or precious metals without thinking of the ethical or geopolitical implications of such an investment; after all, you’re just investing in oil or precious metals, right?
For all the talk of how volatile “the markets” can be it might not seem like a prediction market would improve society’s ability to foretell the future but I’m reminded of those who found themselves quite reasonably skeptical of Wikipedia’s ability to crowdsource accurate information, but look at what has been accomplished! A prediction market focusing on the film industry called Hollywood Stock Exchange called 32 out of 39 major-category nominees and seven out of eight major winners at the 2007 Oscars.
Right now I’m aware of projects by Augur, Gnosis, and Noumerai all experimenting with various ways to create a DPM. DPM’s increase the exchange of information by allowing people to create incentives for other people to use their individual expertise to make predictions about what’s going to happen in the world, allowing for decentralized earning and a world of opportunities to integrate new data points into economic models. We’re talking about actually being able to put a price on change! Imagine being able to create markets based on pollution levels or the amount of corruption in a given industry.
What would it mean if society reaches a point where we can accurately predict more and more major events? We’ve known about climate change for decades and yet in spite of the pressing reality of the situation, a significant number of individuals and businesses still actively pollute the environment in pursuit of personal gain. On the other hand, money is the world’s greatest motivator. By creating the possibility for people to make money on accurate information we can reassemble the systemic forces that make it profitable for people to pollute in the first place!
What if DPM’s filled the void in labor markets once automation renders many current jobs obsolete? We may not need nearly as much labor in the future but the decreased demand for labor coupled with increasing transactions speeds points to higher demand for access to people’s opinions. With some basic mathematical training, an electronic device, and a niche to focus on, any individual could learn how to make predictions or find new data points for people to make predictions on and get paid for their judgment.
I’m not an economist but I’m very interested in money and economics and having done a fair bit of reading about how it works I’m really excited about decentralized prediction markets. Not only do they have the potential to create investment opportunities for people with far more diverse interests, I think they could eventually create opportunities for people who have been disenfranchised. If you’re interested I highly encourage you to check out Augur, Gnosis, and Noumerai.
Please feel free to leave questions in the comments or contact me at firstname.lastname@example.org and Share and Subscribe if you found this article helpful. To the moon!
Disclaimer: I’m not a financial expert; this is not and should not be construed as financial advice. Do your own research before investing and never risk more than you can lose!