What is a Prediction Market?

Key Points:

How It Works: Buy and sell contracts tied to events. Prices range from $0 to $1, representing probabilities (e.g., $0.75 = 75% chance).
Benefits: Offers dynamic odds, lower fees, and real-time updates compared to traditional sportsbooks.
Types: Centralized company-run markets (regulated) and blockchain-based markets (decentralized, global access).
Applications: Useful for sports betting, predicting elections, and more.

Quick Comparison:

Feature	Prediction Markets	Traditional Sportsbooks
Pricing Model	Dynamic, market-driven	Fixed odds
Fees	1-2% trading fee	~10% house cut
Liquidity Options	Can sell before event ends	No early cash-out
Market Coverage	Wide range of events	Mostly sports

Prediction markets combine the logic of betting and the stock market, offering a data-driven way to predict outcomes.

Prediction Markets: Can Betting Be Good for the World?

How These Markets Function

Prediction markets work through a simple trading system where participants buy and sell shares based on potential outcomes of events. Here's a breakdown of how trading, pricing, and payouts operate.

Buying and Selling Event Shares

In prediction markets, traders can purchase shares tied to specific outcomes. For instance, on Polymarket's NBA Championship market, you might buy shares of the Boston Celtics winning for $0.29, which reflects their 29% implied probability of taking the title. Share prices range between $0 and $1, and an automated market maker ensures liquidity by adjusting prices instantly based on trading activity and sentiment.

"Financial markets are generally pretty efficient, and the evidence suggests that the same is true of prediction markets. There's no virtue-signaling in an anonymous market when you're betting and that 'what you're seeing with the market is some average of all of those different opinions, weighted by their willingness to put their money where their mouth is.'" - Eric Zitzewitz, Economics Professor at Dartmouth

Price and Probability Connection

Prices in prediction markets reflect probabilities, which shift in real time as new information becomes available and traders adjust their positions. This creates a dynamic system, especially in sports betting, where odds evolve constantly. For example, current Polymarket probabilities show:

Liverpool: 97% chance to win the Premier League
Boston Celtics: 29% chance to win the NBA Championship

These prices represent the collective knowledge and predictions of traders.

Payout Process

1. Market ResolutionWhen the event concludes, the outcome is verified using pre-set rules and trusted data sources. Trading stops as soon as the market resolves.

2. Dispute ResolutionA dispute period ensures the outcome is confirmed accurately. Major platforms like Polymarket and Kalshi handle significant trading volumes, averaging $13 million per event.

Prediction markets have proven their accuracy time and again. For instance, the Iowa Electronic Markets, active since 1988, have consistently outperformed traditional polling in predicting presidential elections. As experts Wolfers and Zitzewitz explain: "The power of prediction markets derives from the fact that they provide incentives for truthful revelation, they provide incentives for research and information discovery, and the market provides an algorithm for aggregating opinions".

Market Categories

Prediction markets are generally divided into two main types, each with its own approach and advantages.

Company-Run Markets

These markets are managed by centralized organizations that handle trading and settlement processes. They operate within a specific framework, providing a safer environment for users. By carefully selecting events, these companies work to maintain market integrity. However, the involvement of intermediaries can lead to higher operational costs.

Blockchain Markets

Blockchain-based prediction markets rely on decentralized technology, enabling trading without the need for trust in a central authority. Some key characteristics include:

Global Access: Open to anyone with an internet connection.
Lower Fees: Costs are reduced by cutting out intermediaries.
Transparency: All transactions are recorded on a public ledger, ensuring accountability.

"Instead, let us create betting markets on most controversial questions, and treat the current market odds as our best expert consensus. The real experts (maybe you), would then be rewarded for their contributions, while clueless pundits would learn to stay away." - Robin Hanson, Professor at George Mason University

Platforms like Augur and Polymarket highlight the increasing popularity of blockchain markets. However, they come with their own challenges:

Unrestricted Market Creation: This freedom can lead to questionable or inappropriate events being listed.
Technical Barriers: Users need to understand cryptocurrency and digital wallets.
Smart Contract Risks: Dependence on automated contracts means security is critical.

When deciding between these two types of markets, factors like security, accessibility, and costs play a major role. These considerations shape how users interact with prediction markets, paving the way for more advanced applications, including sports betting.

Sports Betting Applications

How Prediction Markets Compare to Sportsbooks

Prediction markets stand out by removing the traditional house edge and allowing peer-to-peer trading. Unlike sportsbooks, which typically take a 10% cut, prediction markets function more like stock exchanges. Here, users trade directly with each other, and prices shift to reflect event probabilities as percentages. This setup offers a different approach to betting, with some clear advantages.

Feature	Prediction Markets	Traditional Sportsbooks
Pricing Model	Dynamic, market-driven	Fixed odds
House Edge	No house edge (1-2% fee)	~10% house cut
Liquidity Options	Can sell before event ends	No early cash-out
Odds Format	Percentage probability	Fixed odds

Smart Betting Strategies

To succeed in sports prediction markets, a data-focused approach is essential. For example, after the Detroit Lions' loss dropped their Super Bowl odds to 17 cents per share, a $10 investment could turn into $58.82 if their performance improved. This highlights the importance of timing and analysis.

Key strategies include:

Studying the Data: Dive into team stats, player performance, and historical matchups.
Anticipating Market Shifts: Pay attention to upcoming schedules and events that could influence prices.
Buying the Dip: Take advantage of price drops caused by notable events or losses.

Challenges to Be Aware Of

Even with solid strategies, bettors face hurdles. Prediction markets require understanding both sports betting basics and market trading concepts, which can be a steep learning curve. Liquidity is another concern, especially for less-followed sports or niche events, where trading activity may be limited.

U.S. Prediction Markets

Industry Outlook

Regulatory changes are reshaping prediction markets, while also lending more legitimacy to sports betting platforms. Congressman Richie Torres of New York has been vocal in his support, stating, "prohibiting these markets doesn't protect election integrity; it actively undermines it by furthering polarization, worsening the public's understanding of our democratic process and promoting unsafe, black market exchanges".

Several key factors are influencing the future of this industry:

Regulatory Changes: The CFTC is hosting public discussions to create a more structured approach to regulating prediction markets, including sports-related contracts.
State-Level Actions: A handful of states like Nevada have cracked down on unlicensed prediction markets offering contracts for sports and elections. Unlike traditional sportsbooks, which operate under state-specific licenses, prediction markets have often tried to function nationwide without meeting these requirements.
Legal Milestones: Court rulings, such as PredictIt's win against the CFTC in July 2023, suggest that the legal framework is evolving, potentially leading to clearer regulations.

Acting Chairman Caroline D. Pham has acknowledged that "delays and anti-innovation policies have restricted the CFTC's ability to pivot to common-sense regulation of prediction markets". This ongoing evolution could pave the way for a more defined and accessible regulatory environment.

Summary

Prediction markets merge elements of sports betting and the stock market, creating platforms where users can trade shares based on the outcomes of future events. The price of these shares reflects the crowd's collective judgment on how likely an event is to happen, offering a data-driven approach to wagering. This makes them stand out from traditional sportsbooks.

Unlike traditional sportsbooks, prediction markets operate on a peer-to-peer model with dynamic pricing and typically lower fees. They also cover a wider range of events, not limited to sports, allowing for more diverse and flexible trading strategies.

The popularity of prediction markets is growing. For instance, during the 2024 election between Donald Trump and Kamala Harris, over 500 million Presidential Election contracts were traded on Robinhood.

As these markets continue to develop, traders are finding ways to capitalize on market shifts. With their mix of data insights and flexible trading options, prediction markets offer advanced tools for those looking to make strategic bets.