Despite being rigorously tested, cutting-edge instruments for forecasting future events, prediction markets will never reach their full potential if built on 21st century database technologies. Traditional prediction market applications operating on centralized platforms have limited accessibility, liquidity, and market variety, and tend towards proprietary designs and siloed data.
In order for a prediction market platform to become truly disruptive, we believe that it must be universal and draw from a global liquidity pool. For such a liquidity pool to exist, the platform must be decentralized, permissionless, and trustless. But what does that mean?
No Counterparty Risk
A platform can only be truly successful if applications are built on top of it. To make sure that this actually happens, application developers need to entirely trust the platform to not change its usage properties sometime in the future, and eventually putting the application operators out of business.
With a decentralized platform powered by smart contracts, applications built on top of the platform do no longer need to trust the platform. Future characteristics of platforms such as usability rules or fee rates will be hard coded into the software itself and are publicly viewable and verifiable. DApp developers on Gnosis will be able to create new classes of predictive assets that can be used in any number of simple or complex applications while being entirely aware of present and future platform characteristics at all times.
While we see this as the core value proposition of decentralized platforms for application developers, it brings the same advantages for end users.
With centralized prediction market applications, the user typically sends funds to the site operator. These funds are then held by a wallet owned by the site operator, and the equivalent value is credited to the user’s account via a database entry. Both the user and the operating company incur counterparty risk: theft (by the site operator or from the site), legal intervention, or unexpected issues with payment processors such as withdrawal capacity restrictions, to name a few. Since users factor the risk of fund loss into their investment decisions, this process results in decreased liquidity.
With decentralized prediction market applications, funds always reside in the user’s control. Users own the account and hold the private keys to access it, which means that they are the only ones who can move their funds — even in the event that the site goes down. Funds which already have been used to purchase market shares will be stored in automated smart contracts, which are incorruptible by humans, and designed to verifiably and automatically pay out correct values upon market resolution.
Through decentralization, the user does no longer need to trust the operating company — risks are, in fact, removed from both the site operator (i.e. Gnosis DApps or applications built on top of it) and the user, resulting in greater market liquidity.
The access to markets needs to be open, equitable, and transparent. Gnosis operates as an open platform where access is unbiased and transparent — it can be reached from anywhere and provides the same markets, pricing, and liquidity to all parties. Anyone with internet access can ask a question and fund a prediction market to find the answer, and anyone can predict an event along with billions of other market participants from all across the globe. Since the platform also provides the back-end logic to create new applications on top of it, the implementation costs that new market entrants face turn out to be at least two times lower than on traditional, centralized platforms.
This will not only increase adoption, but also allow for greater information aggregation. Consider a market on meteorological disasters such as hurricanes in the US. While meteorologists in France may have excellent models to predict hurricane routes and intensity in the US, and have access to a prediction market in order to sell their information, this market will most likely only be accessible by French residents. In the US, however, locals in Florida, North Carolina, or Louisiana may possess more precise current or historical data on factors that greatly increase or decrease a hurricane’s intensity (the Loop Current in the Gulf of Mexico for example). However, they are unable to reveal this information since they don’t have access to the prediction market. With Gnosis, both expert groups can access the same market, adding more unique and accurate information and thus resulting in better probability estimates.
Market Resolution without a Trusted Source
At the resolution of a prediction market, the outcome of an event must be reported. With traditional prediction market applications, this was usually done by the people who ran the prediction market itself, i.e. the operating company. The user had to trust the site operator to correctly report on the event outcome.
With a decentralized system, markets can resolve without a trusted source. Various systems can be used for reporting on event outcomes: a group of people reporting on an outcome where 3 out of 5 individuals need to agree, for example, or token holders voting on outcomes as a crowd (the case for Augur). In these decentralized mechanisms, participants are voting in an economically incentivized way. If they vote along with the majority, they gain some value, if they vote against the majority, they lose value.
If the information is already on Ethereum, however, markets can resolve without requiring individuals to actively and regularly report on the outcome of events, and hence without any operating costs. This is possible through so-called Oracles which automatically capture real-world information and cryptographically confirm that the data is drawn from a trusted data source.
Gnosis built an oracle solution that is centralized by default, but features a truly decentralized failsafe, enabling quicker resolutions without sacrificing the benefits of decentralization, and with the big advantage of not having any operation costs. We look forward to discussing the details of our Oracle approach in a separate post.
With these matters of trust in mind, we’ve selected the Ethereum network as the core protocol upon which the Gnosis platform will be built. Ethereum allows us to run decentralized code with smart contracts, making transfer and settlement of assets simple and censorship resistant. We’ll be able to explore market-driven forecasting technology that truly can be revolutionary, and that lets you shape the future.
<div class="infobox"><span class="appendinfo">This article was originally published on: <a href="https://blog.gnosis.pm/" target="_blank">The Gnosis Blog</a> on </span></div>