Leveraging greed to forecast the future

In the late 1990s Who Wants To Be A Millionaire? was the post popular game show on TV.

The premise was simple, answer 15 increasingly difficult general knowledge questions and you win £1 million.

The contestants were given a choice of four answers for every question, with only one being correct. A pretty standard multiple-choice format.

And each contestant had a little extra help in the form of three lifelines: phone a friend, 50-50 and ask the audience.

Phone a friend was only good if their friend so happened to be an expert on the subject of the question.

They made out like the friend was just going about their normal day, but they were most likely in another room of the studio to stop any cheating. No one was ever out or busy when the presenter, Chris Tarrant, rang.

50-50 usually left the two answers that both seemed equally likely.

But ask the audience was almost always the most useful. Basically the audience voted on which answer they thought was right, and the results were displayed as percentages to the contestant.

The audience was rarely wrong.

The reason why goes back to what’s termed “the wisdom of crowds”. Basically it means that for prediction, crowds do better than individuals.

The most famous study of this comes from 1906.

At a fair in Plymouth, there was a competition to guess the weight of an ox. The person who came closest got to take the butchered animal home.

Statistician Francis Galton noticed that the average (median) guess of the 800 people was within 1% of the ox’s actual weight.

So, given the crowd’s aggregate guess is much more accurate than any individuals, we can use this knowledge to get answers to many difficult questions.

A great example of this is how the financial markets work. As Eoin Treacy often says in his videos, the markets show what people are actually doing, not just what they say they are doing.

That’s why a good way to get a different perspective on the news is to look at the markets. However, traditional financial markets are fairly limited in this scope.

Sure, you can track the prices of commodities, currencies and stockmarkets. But you can’t exactly see what the crowd thinks about, say, the winner of the next general election. Or when the next person will walk on the moon. Or when we’ll all have driverless cars. Or what Google’s Q3 profit will be.

Of course, you could conduct polls. But in any controversial issue, people might not give their true answer. Just look at how wrong the polls were on Brexit, Donald Trump and our last general election.

Plus, with no “skin in the game” those polled might really care how good their answer was.

In order to get good data on these things, people need to be honest about their opinions. And that’s where prediction markets come in.

The (prediction) market doesn’t lie

Prediction markets are more than just sports betting. They allow you to bet on practically anything.

They work in a similar way to financial markets, but for people’s predictions.

The prediction is worth whatever the market decides it’s worth. If the crowd thinks the prediction is likely to come true, that will be reflected in its price.

If the markets are run peer-to-peer then the predictions will become extremely accurate. Unlike traditional betting, where a bookie sets the odds and adjusts them as they get more bets in, peer-to-peer markets balance themselves.

Here’s how the prediction market PredictIt explains its platform:

PredictIt allows you to make predictions on future events by buying shares in the outcome, either Yes or No. Each outcome has a probability between 1 and 99 percent. We convert those probabilities into US cents.

For example, Trader A thinks an event has at least a 60 percent chance of taking place so she offers 60 cents for a Yes share. PredictIt matches her offer with that of Trader B, who is willing to pay 40 cents for a No share. Each trader now owns a share in the market for this event on opposite sides.

The prices of shares will change over time and both traders could decide to sell their shares at any time. A key to success at PredictIt is knowing when to sell in order to take a profit or prevent a loss.

If an event does take place, all Yes shares are redeemed at $1. Shares in No become worthless. If the event does not take place before the market closes, traders holding shares in No will be paid $1, while Yes shares will be worthless.

Every market asks a specific question about a potential future event. Some markets feature questions that have simple Yes or No answers, while others offer multiple possible outcomes. Each of these options is known as a ‘contract.’

The exciting thing about peer-to-peer prediction markets isn’t so much the market itself, but what we can learn from the prices within it.

We can use prediction markets to get more accurate data than polls or surveys or political gossip. These markets let us know what people are really thinking.

Where these prediction markets run into issues now is they are very limited in their scope.

The problem with predictions

With the current prediction market model, you can only bet on what the company running the markets lets you bet on.

Yes, they may run the actual bets peer-to-peer – as Betfair does. But what you can bet on is very limited.

For example, Betfair only lets you bet on sporting events. And as far as I can see, PredictIt only lets you wager on political events.

Enter crypto.

It seems like there is a crypto solution to everything, doesn’t it?

The main benefit of prediction markets built on crypto is that they are run by the crowd.

Anyone can set up a bet on any event or prediction. If people want to bet on it, they will. The market can’t be censored or taken down.

I imagine this will lead to some pretty dark markets, like betting on when a celebrity will die. Or betting then the next major earthquake will happen.

But even then, those markets would provide valuable information – why do so many people thing the next major earthquake will happen in country x? Have there been warning signs, should we be looking into this?

Why does the market think celebrity x will die within the month? Perhaps they need help. Etc.

Those ghoulish bets could actually end up saving lives.

Crypto prediction markets will make hedge fund managers of ordinary people

User-created markets will also mean people be able to hedge against business disasters.

An example I’ve seen online is a farmer setting up a market to bet on the rainfall in their region. They put out a bet that it won’t rain. If it rains, they can make money off growing their crops. If it doesn’t rain, they win their bet and still make some money.

Financial firms have hedged their stockmarket bets for years. Hence the term “hedge fund”. With crypto-powered prediction markets, anyone will be able to hedge against anything. So long as people want to buy the other side of the bet.

Another example I’ve seen is for politics. Candidates could publically bet on themselves implementing their policies if they get into office.

How many times have politicians broken their promises once they made it into office? What if they were forced to put their money where their mouth is?

For example, candidate x could personally bet £5 million that they will increase public spending on the NHS if they get in. Sure they still might not do it, but if they don’t they lose £5m.

All it would take is one big name to do this in their campaign and the others would have to follow suit. It could lead to a world of politicians actually being held to account. Imagine that!

Once you start thinking about it, the possibilities for crypto prediction markets are endless.

That being said, right now, none of the crypto prediction markets are ready for the main stage.

A couple of weeks ago Augur launched to great fanfare. But even its own people admit it’s slow and expensive.

“We’re trying to stream HD videos in 1995, it just ain’t gonna happen,” Augur co-founder, Joey Krug wrote last month on Reddit.

It looks like we’ll have to wait for crypto to iron out its kinks before these markets become widely used. Kurg reckons Augur will have “100x improvement within 12 months.”

I guess we’ll have to wait and see on that one. Perhaps he should make a bet on it using his own platform.

Once these platforms get into gear, they really could change how the world works.

Until next time,

Harry Hamburg
Editor, Exponential Investor

Category: Cryptocurrency

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