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Prediction Markets – A Complete Guide for Beginners

Predictions are a big part of our lives. From predicting how many marks you might get in an exam to which team would win the football world cup final, we predict a plethora of things. Some people turn their habit of predicting accurately into lucrative earnings by leveraging their knowledge, studying statistics, and sometimes, just getting lucky.

This is where prediction markets come in. The industry is big and is expanding rapidly, with hundreds of people joining in every day. Some expert forecasters have hit the jackpot with their predictions, and a few have built their fortune from it. If you are new to the concept of prediction markets, this blog is exactly what you’ll need to get started. 

What Exactly is a Prediction Market? 

A prediction market is a type of market where you can trade the results of future events by making predictions and earn money if you’re right.. . Governmental Elections, corporation sales, commodity price swings, even shifts in the climate, and almost any occurrence or result that can be realistically proven ex-post are examples of such occurrences (but are not restricted to them).

Prediction markets are fundamentally event derivatives, in which the valuation of the derivative will represent the likelihood of a result materializing based on the information available. The notion of prediction markets has been around for years, but with the advent of blockchain technologies (such as decentralized governance structures, cryptographic protocols, and so on) that leverage the idea, a new level of interest in these tools has been sparked.

Companies like Futuur, Kalshi, and Predictit are using prediction markets to generate insights about the future in the form of crowd-generated forecasts.  These websites allow the users to make predictions about politics, sports, and even science.  If you crack your ability to predict, you can earn a lot more than you can imagine. 

Photo by Mikhail Nilov

Significance of Prediction Markets 

As a predictive tool, prediction markets have shown to be highly useful. A number of large corporations have used prediction markets internally to predict things like product release timing.   The increasing complexity of the world economy, geopolitics, and cultural concerns has only increased the need for accurate predictions.  Prediction markets fill this gap and can be considered a highly effective example of the broader notion of crowdsourcing. 

Crowdsourcing is a method of gathering information from multiple individuals and points of view on a given topic.  By using the “wisdom of the crowd,” these systems generate results that are usually more accurate than any given individual, even if they are an expert.  

Types of Prediction Market 

Here are the most common types of prediction markets: 

  • Automated Market Makers 

When there aren’t enough potential sellers and buyers in prediction markets, an automatic market maker (AMM)  is utilized to create liquidity. The automated market maker is an algorithm that serves as a mediator to the transactions in the market. The algorithm determines pricing and payouts for each transaction depending on the volume of bets placed on each result.

  • Continuous Double Auction

Like most stock markets, a continuous double auction is a form of trading procedure for pairing buyers and sellers through a book of orders or an order book. Traders purchase or sell bets on a specific event against other traders in the market, resulting in prices that rise or decline depending on how much buying or selling there is in a given outcome.  

  • Play Money Markets 

Although most prediction markets use real money to reward correct predictions, this might cause issues in states and countries where internet gambling is prohibited. Several prediction markets offer play money betting, which avoids some of the legal restrictions placed on real money gambling.  Future, for instance, offers both play-money and real-money markets, while other platforms like Metaculus use play-money exclusively.

The beauty of prediction markets is that they tap into the collective knowledge and diverse views of the population. They can create forecasts that are generally more trustworthy and accurate than any individual expert view by gathering and integrating the opinions of a large number of investors. Traders are incentivized to make correct forecasts by the prospective rewards and, as a result, contribute high-quality information we predict a bright future for this innovative mechanism.

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