The Hidden Power of Prediction Markets: A Litmus Test for the World

Prediction markets might seem fun and degen, but they actually serve as humanity's oracle. Check out this article for key findings from Delphi's latest report on prediction markets.

Today's spotlight is on Delphi's report, “Markets Will Save The World”. As I read it, my view on prediction markets shifted from "Whoa, that's just the new setting for binary options" to "Wow, this is indeed a huge thing." I can confidently say this is one of the Delphi team’s best works, and I am excited to share its highlights with you.

To enjoy this read, you should be prepared to zoom out and view prediction markets not as an end user, nor even as an investor.

Ready? Me too.

What unites AI and prediction markets?

Both ChatGPT and prediction markets serve similar functions: ChatGPT answers questions, while prediction markets forecast events. ChatGPT accesses all online knowledge but can't make unbiased judgments based on it. It knows the past and understands what others think about future outcomes, yet remains passive.

The market can be viewed as a form of general intelligence. Although there are key differences, the similarities between markets and AI models like GPT-4 are striking. Both train on vast amounts of human-generated data, compress immense knowledge, and implicitly mirror our world back to us.

However, we ask markets few questions and don't empower them to take action. Instead, we often perceive markets as fickle slot machines, judging them by the answers they provide.

Prediction markets actually offer something distinct from today's AI tools. They are increasingly seen as reliable information sources, functioning as "truth machines."

Collective intelligence

Unlike AI models like ChatGPT, which rely on developers' expertise, Polymarket depends on the collective opinions of its users. The crucial difference lies in the source of trust: ChatGPT requires trust in its developers, while Polymarket is grounded in the consensus among its participants, serving as a tool for assessing collective knowledge.

Interest in prediction markets is growing because they help uncover truth through user forecasts. This is increasingly significant as trust in institutions like the media and government wanes, with prediction markets stepping in to fill that gap.

A notable example of the value of prediction markets is the 2024 presidential election.

In September 2023, Polymarket estimated Joe Biden's chances of withdrawing from the race at 22%, well ahead of traditional polls and expert opinions. As summer 2024 neared, despite his team's public assurances, prediction markets continued to adjust his chances downward. By July 2024, the prediction proved accurate—Biden officially withdrew from the race.

Another example is the shifts in prediction markets during the debates between Trump and Kamala Harris. Within 20 minutes of the debates starting, predictions began to turn against Trump, influencing public opinion and social media discussions. This illustrates how prediction markets can correct biases and serve as an objective source of information.

The drivers & challenges

In 2024, 78% of Polymarket's trading volume was tied to elections. Activity is expected to decrease after November 5 but will likely surge prior to the election, reflecting trends from 2020.

However, a significant challenge for Polymarket and other prediction markets remains low liquidity.

Low liquidity causes market inefficiencies, making them less reliable.

For instance, placing large bets, such as $1 million on Kamala Harris's victory, can lead to significant price slippage. Insufficient liquidity complicates large traders' ability to enter or exit positions, increasing the likelihood of distortions, such as bias. For example, many Polymarket users share similar political views, which amplifies correlated bias.

Another critical issue is the functioning of oracles like UMA, which can delay dispute resolutions even when the facts are clear. A notable case involved a dispute regarding Justin Bieber's child that became complicated due to the platform's technical rules.

Possible alternatives include shifting to a centralized dispute resolution system or implementing AI oracles to enhance the user experience.

The zero-sum nature of prediction markets makes them less appealing to traders, as one person's gain requires another's loss. This dynamic complicates profit potential.

User bias and liquidity issues are also significant. Notably, 95% of Polymarket's trading volume comes from only 20 traders, rendering the market vulnerable to manipulation.

For example, a group of large traders attempted to sway the presidential election market in favor of Kamala Harris but lost $60K due to quick responses from other participants.

The landscape of the market

Over the next 6-12 months, approximately 25 new platforms are expected to launch, intensifying competition.

Polymarket remains the market leader, while Azuro is trying to catch up by offering liquidity to other platforms. Interestingly, despite having its own token, Azuro struggles to compete with Polymarket, which operates without one.

Drift, a platform based on Solana launched in August 2024, is gaining attention for its integration with perpetual DEXs and lending platforms. It offers over 30 types of collateral for betting, helping to reduce opportunity costs through built-in yields.

New platforms are emphasizing innovation, focusing on decentralization, enhanced user experiences, and new betting categories like pop culture, gaming, and SocialFi. SocialFi is already emerging on Polymarket through social betting discussions. The use of AI for dispute resolution also shows promise by increasing decision-making accuracy.

Azuro and Drift offer unique approaches centered on decentralization and improved user interaction, which could transform the market in the coming years.

Is futarchy the future?

Both ChatGPT and prediction markets serve similar purposes: ChatGPT answers questions, while prediction markets forecast events. However, they are passive tools and do not directly lead to real changes. To create impact, active decision-making is necessary—AI agents for AI, and futarchy for prediction markets.

Futarchy, a concept proposed by Robin Hanson in 2000, involves making decisions through market mechanisms rather than voting. In 2023, developer Prophet implemented futarchy in MetaDAO on Solana.

Unlike Polymarket, where users bet on what should happen, MetaDAO is developing decision markets where users wager on what they believe will happen.

In prediction markets, you're passive. You sit on the couch, watch the game, and bet on who you think will win. You have skin in the game but no control over the score.

Decision markets are different; they're active. By speculating, you actually influence the outcome. This dynamic allows participants to trade proposals and shape outcomes, enhancing decision-making efficiency and promoting economic development.

Personal thoughts

Markets offer more than mere speculation or the pursuit of gains in a zero-sum game. They provide valuable data.

Curious about tomorrow's trending topics on your X timeline? Check the charts for the top gainers—this pattern has appeared with memecoins, Solana, Sui, and many others. Price action often precedes discussions, which in turn amplify price movements.

Sometimes, all you need is to watch the charts and let them speak.