Blockchain Revolution

THE MARKET FOR PREDICTION MARKETS
Augur is building a decentralized prediction market platform that rewards users for
correctly predicting future events—sporting events, election results, new product
launches, the genders of celebrity babies. How does it work? Augur users can
purchase or sell shares in the outcome of a future event, the value of which is an

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estimate of the probability of an event happening. So if there are even odds (i.e.,
50/50), the cost of buying a share would be fifty cents.
Augur relies on “the wisdom of the crowd,” the scientific principle that a large
group of people can often predict the outcome of a future event with far greater
accuracy than one or more experts.
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In other words, Augur brings the spirit of the
market to bear on the accuracy of predictions. There have been a few attempts at
centralized prediction markets, such as the Hollywood Stock Exchange, Intrade, and
HedgeStreet (now Nadex), but most have been shut down or failed to launch over
regulatory and legal concerns. Think assassination contracts and terrorism futures.
Using blockchain technology makes the system more resilient to failure, more
accurate, and more resistant to crackdowns, error, coercion, liquidity concerns, and
what the Augur team calls euphemistically “dated jurisdictional regulation.” The
arbiters on the Augur platform are known as referees and their legitimacy derives
from their reputation points. For doing the right thing—that is, correctly stating that
an event happened, who won a sporting match, or who won an election—they receive
more reputation points. Maintaining the integrity of the system has other monetary
benefits: the more reputation points you have, the more markets you can make, and
thus the more fees you can charge. In Augur’s words, “our prediction markets
eliminate counterparty risks, centralized servers, and create a global market by
employing cryptocurrencies including bitcoin, ether, and stable cryptocurrencies. All
funds are stored in smart contracts, and no one can steal the money.”
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Augur resolves
the issue of unethical contracts by having a zero-tolerance policy for crime.
To Augur’s leadership team, human imagination is the only practical limit to the
utility of prediction markets. On Augur, anyone can post a clearly defined prediction
about anything with a clear end date—from the trivial, “Will Brad Pitt and Angelina
Jolie divorce?” to the vital, “Will the European Union dissolve by June 1, 2017?” The
implications for the financial services industry, for investors, economic actors, and
entire markets, are huge. Consider the farmer in Nicaragua or Kenya who has no
robust tools to hedge against currency risk, political risk, or changes to the weather
and climate. Accessing prediction markets would allow that person to mitigate the
risk of drought or disaster. For example, he could buy a prediction contract that pays
out if a crop yield is below a certain level, or if the country gets less than a
predetermined amount of rain.
Prediction markets are useful for investors who want to place bets on the outcome
of specific events such as “Will IBM beat its earnings by at least ten cents this
quarter?” Today the reported “estimate” for corporate earnings is nothing more than
the mean or median of a few so-called expert analysts. By harnessing the wisdom of
the crowds, we can form more realistic predictions of the future, leading to more
efficient markets. Prediction markets can serve as a hedge against global uncertainty

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and “black swan” events: “Will Greece’s economy shrink by more than 15 percent
this year?”
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Today, we rely on a few talking heads to sound the alarms; a prediction
market would act more impartially as an early warning system for investors globally.
Prediction markets could complement and ultimately transform many aspects of
the financial system. Consider prediction markets on the outcomes of corporate
actions—earnings reports, mergers, acquisitions, and changes in management.
Prediction markets would inform the insurance of value and the hedging of risk,
potentially even displacing esoteric financial instruments like options, interest rate
swaps and credit default swaps.
Of course, not everything needs a prediction market. Enough people need to care
to make it liquid enough to attract attention. Still, the potential is vast, the opportunity
significant, and access available to all.