Tag: cryptoeconomics

TOKEN PREDICTION MARKETS

Prediction markets are speculative markets, very similar to futures markets, which have been designed so that the prices can be interpreted as probabilities for events occurring and used to make predictions.

Put very simply, prediction markets enable users to trade shares in the outcomes of an event and in so doing to reveal the information that people have about the likelihood of an event occurring.

In a very elegant way, blockchain prediction markets use tokens to reduce uncertainty and find truths about future events. As they align truthful statements with token investments they create a way for people and groups to come to consensus about a shared conception of reality by using markets to create valid sources of information.

HOW IT WORKS

A number of blockchain based prediction markets now exist such as Augur, Stox or Gnosis. Using one of these networks anyone anywhere in the world can create a market for people to try and predict the outcome to some event, such as a sports match, an election, the weather, sales of a company, price fluctuations of commodities, the availability of almonds in Spain next year or the likelihood of a conflict occurring in central Asia at a given time.

Market makers provide initial funding for the market and for this receive some trading fees. Anyone can then buy and sell shares in the outcomes of that market.

Predictions are based on a binary event where something either will or won’t happen. The value of a bet will in most cases reflect the probability of an outcome materializing.

If you place a bet on a coin flip, the outcome will always be 50% heads, 50% tails. There are no external market conditions that will influence the outcome.

Luck plays a major role, and this is called gambling.

But prediction markets rely on the collective wisdom held by a group of people on the probability of a future event materializing. The current market price of a share is an estimate of the probability of an event actually occurring. The prices of each share add up to one dollar. So if you buy a share at even odds it will cost you 50 cents. If you end up being right, you’ll receive a dollar for that share. If you see a market price of 53 cents then it is reasonable to assume that there is a 53% chance that outcome will occur.

As an example, we can think about a market for the hiring of a new CEO of a company given just two candidates, Bob and Jane. In this market, one share for the Bob option pays you a euro if he is hired and pays you nothing otherwise. One share for Jane pays you a euro if you hold the share and she is hired, and pays zero if she is not. Now, suppose you think Jane has a chance of winning that position, how much would you be willing to pay for a Jane share? If a Jane share pays a dollar if Jane wins and she has a 70% chance of winning, then that share is worth 70 cents. You would be willing to pay up to 70 cents for such a share.

Suppose you enter this market and you find that Jane’s shares are selling for just 55 cents, well, that’s a buying opportunity. Something which you think is worth 70 cents is selling for 55, so then, you should buy the Jane option. In buying the shares, you would be pushing up their price. In this way, your predictions, your information, your opinions about which candidate is likely to win become incorporated into the price of a Jane share.

Imagine however you thought Jane had a 70% chance of winning but her shares were selling for 80 cents, then, you would want to sell Jane shares. Even if you really wanted Jane to win the position of CEO. To make more money you would sell the Jane shares and buy the Bob share. In this way we can see how prices come to reflect the market information.

The prediction market really boils down to one number and if there’s anyone in the world who thinks they would know better than this number they have direct financial incentives to trade this market and basically with every trade they make they feed the information into this market and in the end we have a better number from the market.

The outcome becomes more predictable over time. This is because the payoff depends on the accurate prediction of an outcome of an event. As a larger number of people do more market research to come to the most likely conclusion, the predicted outcome will lean more favorable to one side. Current share prices over time come to reveal information about the likelihood of an event occurring according to the information gained from the market participants.

ADVANTAGES

Prediction markets are not a new invention. They are in fact centuries old and have proven their effectiveness many times.

One of the most popular current markets is the Iowa Electronic Markets. In over two decades of testing this market, in presidential elections, congressional elections, and state elections, the market prices from the Iowa Electronic Markets have turned out to be better predictors of the outcomes than have political polls.

The two key features that make them successful is that firstly, they draw upon dispersed information that is consolidated and averaged out. And secondly people have skin in the game, that is to say people are putting their own money on the line and this ensures a correspondence between what they predict and what they believe to be true.

Prediction markets work to align incentives by backing statements up with resources. They work to obtain truthful and relevant information through financial and other forms of incentives. With real money on the line, people have an incentive to think carefully when they’re investing and they have an incentive to collect, process and interpret all of the information available all over the world. The resulting market prices potentially reflect a lot of deep-seated and diverse information in a way which surveys or polling cannot.

Likewise because prediction markets rely on the collective view of many, not just one person’s research, they can efficiently aggregate a plethora of information, beliefs, and data.

These markets work on the principle of the wisdom of the crowd, which states that if you ask enough people something, their average answer is usually far more accurate than anyone expert, which creates a powerful forecasting tool.

The author James Michael Surowiecki posits that there are a number of necessary conditions for collective wisdom: independence of decision, diversity of information, decentralization of organization.

In the case of predictive markets, each participant normally has diversified information from others and makes their decision independently.

The market itself has a character of decentralization compared to expertise decisions. Because of these reasons, predictive markets are generally a valuable source to capture collective wisdom and make accurate predictions.

Equally the ability of the prediction market to aggregate information and make accurate predictions is based on the Efficient Market Hypothesis, which states that assets prices are fully reflecting all available information. For instance, existing share prices always include all the relevant related information for the stock market to make accurate predictions.

Prediction markets create a very dynamic system, as opposed to a seven-year plan or a yearly assessment, prediction markets can incorporate new information quickly and may be continuously updated.

BLOCKCHAIN

Using a blockchain as the IT infrastructure adds additional benefits to prediction markets. By creating prediction markets on a blockchain network we can ensure that the data always remains open and accessible to all parties. It removes the possibility for the centralized authority to alter results, it can thus be trusted, is secure and if designed well blockchain prediction markets may be difficult to manipulate.

Prediction markets may be used to provide liquidity and hedging around all forms of futures markets. We could have a prediction market for “will the price of bitcoin be more than ten thousand dollars on the first of January 2019.”

All futures markets could be migrated to the blockchain using prediction markets. Likewise, all betting, such as online sports betting, could be more securely and efficiently run on blockchain platforms.

Migrating all of these disparate betting, derivatives and futures markets, to the blockchain could create a much more interoperable system where different networks could automatically draw upon the wisdom of a given network through APIs that connect into the price of the token.

These prediction markets could work as networks that aggregate the best knowledge that we have about a given unknown event. With the knowledge in those networks then being accessible for automatic external use in smart contracts via APIs.

A smart contract ensuring a wedding event could plug into a token market predicting the outcome for the weather on a certain day and use the token price to calculate the likelihood and cost of a weather disturbance to formulate the cost of the insurance claim.

INITIAL COIN OFFERING

ICO, Initial Coin Offerings or first token sale, has become a new way to bootstrap a community, through pre-selling tokens that give users access to the futures services that the network will deliver. In an ICO, a quantity of the crowdfunded cryptocurrency is redistributed to investors in the form of “tokens”, in exchange for fiat currencies or other cryptocurrencies.

These tokens become functional units of currency when the ICO’s funding goal is met and the project launches.

The first token sale was held by Mastercoin in July 2013. Ethereum raised money with a token sale in 2014, raising approximately $2.3 million in just 12 hours. Today first token sales have become hugely popular within the blockchain community. At least 400 ICOs have been conducted as of August 2017.

According to Cointelegraph, companies raised around $6 billion via ICOs in 2017.

Already by February 2018, an estimated 46% of the 2017 ICOs had failed; proving how risky an investment they are.

Ethereum is (as of early 2018) the leading blockchain platform for ICOs with more than 80% market share. Tokens are generally based on the Ethereum ERC20 standard.

In contrast to initial public offerings (IPOs), where investors gain shares in the ownership of the company, in ICOs, the investors buy coins of the company, which can appreciate in value if the business is successful. These coins are sometimes “pre-mined”, eliminating the need for proof of work. Often contributions are capped at a certain value.

ICOs are a way for self-funding a project by selling future access to the service the network will deliver. As such they can be seen as an extension of the crowdfunding process, but different in important ways.

How do ICOs differ from IPOs or issuing shares? When you’re investing in stocks what you’re doing is you’re taking a piece of the equity, a piece of the operating company, all the cash flows. The holder of the equity owns a part of all of the profits that the company makes.

Generally speaking, tokens are different. You’re not buying a part of an operating company you’re buying the money supply of the future technology project.

With tokens, one is buying the tokens before the company has built the technology. But if the technology grows and if it’s well used then the value of the tokens will correlate with the value of the company. Most tokens do not actually provide any sort of claim to an underlying asset and that is different from traditional securities.

ICO DYNAMICS

The token may start as “magic internet money” but as the ecosystem matures and becomes more valuable in use the tokens start to look like and feel like “real money” to their end users.

Any one or group of people can launch a project where ever they see an opportunity for value creation through the coordination of people’s activities.

At first, people come together and define what the future service of the network will be and then create a token that will be the medium for accessing and exchanging that service.

At first, the project is nothing but an idea and a little bit of code on the blockchain for minting some new tokens during the initial offering.

Often when a token is first issued it has essentially zero value. The value of the token at this point is largely dependent upon people’s perceived future utility of the network. Thus the early purchasers of the token are both believers in the network and risk takers. But they give the token value through their belief in its potential and willingness to pay for it. Over time as people contribute to the project the network starts to materialize and at a point, it can be opened up to the community and start to deliver a service to the end user.

At this stage, the tokens that were previously just crypto equity, now become utility tokens which are used to benefit from the services in the ecosystem. Anyone who has contributed to the community, in the beginning, can now use the crypto-equity to benefit for free from the service that is provided. Those that did not contribute have no tokens and they now need to purchase those tokens which gives the token more value as more people use the network and it matures. At this mature state, the token should shift from being an object of speculation to the actual use-value determining its price.

So money which starts as “magic internet money” becomes “real money” as the community materializes and starts to deliver a real service that people would otherwise be paying for with fiat currencies. The token actually starts to feel like real money.

COMMUNITY GROWTH

Part of what blockchain technology enables is for our newly formed network systems of organization to mature and become greatly more autonomous.

ICOs are a way for these networks to become autonomous in their initial financing, to become self-funding.

Token offerings can provide a very agile development model. As with this model to funding it is now possible to set up an organization rapidly wherever there is a perceived business opportunity and for anyone to invest in that organization with limited friction. Unlike in traditional venture capitalism, contributors can transfer their assets instantly and easily to other people.

Whereas previously only projects that could pass through the formal financial system and look like profitable enterprises received financing, with token offerings people can finance the things that they value directly peer-to-peer.

Take for example the blockchain project ImpactPPA, that uses blockchain technology to provide a direct vehicle for people to invest in energy projects in developing economies.

ImpactPPA tries to use the power of the blockchain to bring together capital and consumers in a way that is direct, responsive, and expedient.

Energy financing and distribution are currently bottlenecked by large, centralized NGOs and government agencies that have established a lengthy financing system that can take years from proposal to product implementation.

ImpactPPA offers a system that permits anyone, anywhere, to create a proposal for a project of any size enabling the funding of clean energy microgrids in emerging economies around the world.

ImpactPPA CEO Dan Bates explained that the current funding process with centralized NGOs is “too cumbersome and costly for many developing nations… ImpactPPA’s use of the blockchain and the crowd dramatically changes this paradigm, tapping into the vast potential of the socially minded impact investor and concerned citizen, looking to benefit the well-being of others while mitigating climate change.” – https://goo.gl/NY9Gv4

EXAMPLES

With token offerings, suddenly it’s possible to create all these business models that didn’t exist before which allow us to monetize open data and open networks in a completely new way.

ICOs have the potential to unlock huge amounts of untapped resources and fund projects that would otherwise fall outside of the mainstream financing system as they can be used to provide resources for any kind of project.

Building a new park in your neighborhood could be funded through an ICO. People come together to form a plan for the park, they then create park tokens on the blockchain, inform everyone in the area of the project and that to access its services they will need park tokens.

Tokens are distributed and used to remunerate those creating the park and maintaining it.

There doesn’t even necessarily need to be any fiat money involved; people who contribute receive tokens that they then use later to avail of the park’s services.

Although we often think about ICOs in terms of investment and monetary increases, the token offering can be used to fund any project that may or may not have monetary value. It is simply a way of recognizing the contributions that people have made to the development of a project and rewarding them with access to the service that the system delivers at a later date, thus creating a self-funding, self-sustaining system, that can be completely independent of traditional market financing or government support.

This model supports the idea of multi-value as it actually becomes now possible to have a variety of value systems in the sense that every organization can have its own tokens and those tokens are actually representing what is the value system of that community.

While it is always possible to exchange the token for a particular fiat currency it also becomes possible to create enough systemic exchange by which certain communities that see value in the token of another community can start exchanging between them and eventually you can actually create a really sophisticated system of exchange that could almost bypass the fiat currency.