{"id":25692,"date":"2015-11-12T19:29:15","date_gmt":"2015-11-12T19:29:15","guid":{"rendered":"http:\/\/ci027cfe78c0042697"},"modified":"2015-11-12T19:29:15","modified_gmt":"2015-11-12T19:29:15","slug":"how-prediction-markets-could-guide-bitcoin-s-future-1447356555","status":"publish","type":"post","link":"https:\/\/bitcoinmagazine.com\/markets\/how-prediction-markets-could-guide-bitcoin-s-future-1447356555","title":{"rendered":"How Prediction Markets Could Guide Bitcoin’s Future"},"content":{"rendered":"
<\/div>
<\/figure>\n

While opinions on Bitcoin’s future differ, most agree that the current scalability debate has become a mess. Trolling, misinformation, populism, vote manipulation, vocal minorities, censorship and other distractions have made it hard to find a signal above the noise<\/a>. <\/p>\n

And importantly, if protocol development is going to be driven by what seems like popular opinion on message boards, this could potentially ruin the whole Bitcoin project. <\/p>\n

The essence of this problem, Yale researcher and Truthcoin<\/a> Chief Scientist Paul Sztorc argues, is that \u201ctalk\u201d does not scale. <\/p>\n

\u201cThe real function of a debate is for people to examine each others’ reasoning, and find some area of agreement, or maybe highlight areas where they don’t agree,\u201d Sztorc told
Bitcoin Magazine.<\/p>\n

\u201cBut debates do not scale,\u201d he said. \u201cIt’s literally O(n^2) scaling: With five people, you need at least 10 conversations in order to know that everyone is on the same page \u2026 with 50 people, you need at least 1,225 connections. If someone changes their mind or learns something new, that\u2019s all reset. So it\u2019s no surprise \u2013 to me \u2013 that the conversation is becoming socially dysfunctional at around this time.\u201d <\/p>\n

Luckily, Sztorc believes there is a solution for this problem: prediction markets. <\/p>\n

Prediction Markets<\/strong><\/p>\n

The concept of prediction markets is not new, Bitcoin legend Hal Finney<\/a> advocated them years ago<\/a>. <\/p>\n

Basically, prediction markets are markets for so-called \u201cevent derivatives,\u201d which represent a possible future event. \u201cHillary Clinton will be elected president of the United States in 2016\u201d could be such an event, for example. The relevant derivative might then be redeemable for one dollar if Hillary Clinton is indeed elected, but will be worthless if she is not elected. Up until the election, this derivative will be tradeable on the prediction market. As such, it will command a market price. <\/p>\n

It then holds that this price would reflect the likelihood of Clinton becoming the next president, according to the market. If the Clinton token is worth 40 cents, the market gives her a 40 percent chance of winning the election. After all, if market participants expected a higher chance of her winning, they would buy these derivatives \u201cat a bargain,\u201d and the exchange rate would go up. And if market participants would expect a lower chance of her winning, they would sell (or short) these \u201cexpensive\u201d derivatives, and the price would go down. <\/p>\n

\u201cThe great thing about markets,\u201d Sztorc explained, \u201cis that they are incredibly decentralized \u2013 anyone can partake. This is good because, by definition, you don\u2019t know who has what information, and people won\u2019t want to give valuable info away for free. At the same time, markets present information that is unanimously and constantly acceptable. If you have a room full of 5,000 people, those who agree with the current rate would just do nothing. The price is \u2018good enough,\u2019 as far as they are concerned. Yet
any
person with a strong enough conviction can edit the price by buying or selling the event derivative, and update the exchange rate. They can improve the forecast and make money at the same time.\u201d <\/p>\n

The Great Noise Filter<\/strong>
<\/h2>\n

Furthermore, prediction markets could be a great filter for uninformed opinion, or \u201cnoise.\u201d Unlike message boards, chat rooms and mailing lists, partaking in a prediction market would come at a cost. Sztorc, therefore, expects that people who didn’t invest the time and effort to really, deeply understand an issue won’t get involved at all, as they would be unwilling to invest money, too. <\/p>\n

Talk is cheap,\u201d Sztorc argued. \u201cBut people who really don’t know anything, or know how complicated a situation is, will probably not want to put their money down. And even if they do, even if a fool pushes the price around, there is now money to be made by well-informed people who can pull the market back toward realistic expectations.\u201d <\/p>\n

\u201cThe same is true for manipulation,\u201d he said. \u201cEveryone wants more money, while only a few people will want to knock a market in a certain direction. As such, markets inherently resist dishonesty. Unlike anything else, there is a force pulling the market rate towards reality. They just plain do a good job of getting the right answer, over time.\u201d <\/p>\n

Joint probability<\/strong>
<\/h2>\n

Prediction markets can show us the expected future. But, much better, they can also be used to compare multiple expected futures. <\/p>\n

Through funky constructions<\/a>, it’s possible to make predictions about specific scenarios. For instance: \u201cIf Hillary Clinton is the next president of the United States, then the stock market will rise.\u201d Now, if Clinton is not elected president, anyone who bet on that scenario will get their money back, regardless of what the stock market does. It’s only if she is elected, that the stock market comes into play. If Clinton is elected and the stock market then indeed rises, whomever predicted that correctly wins money. But if Clinton is elected and the stock market drops, they will lose money. <\/p>\n

This also means that market participants can insure themselves against future events. Someone who holds stocks can insure himself against \u2013 say \u2013 a Donald Trump presidency, by betting that the stock market will drop if Trump wins. The bettor might still lose money on the stock market, but win money on the prediction market at the same time, canceling out his losses. <\/p>\n

And, of course, these market rates will also be public for anyone to see. So now, prediction markets are not just predicting possible events, but consequences of possible events. While<\/p>\n

a
ll
presidential candidates will probably claim that the stock market will rise if they are elected, prediction markets reveal who the market believes is right. Rather than empty promises, voters can base their vote on market information. <\/p>\n

Bitcoin Governance<\/strong>
<\/h2>\n

So how is any of this relevant for Bitcoin’s governance process? <\/p>\n

Let\u2019s take the block-size dispute as an example, and assume that everyone wants the exchange rate to go up. (Note that this is not necessarily true; some people value Bitcoin for other properties than its price. However, even then, the expected price could inform specific aspects of the debate, such as the security offered by the value of the mining reward<\/a>.)\u200b <\/p>\n

First, a prediction market regarding bitcoin’s price as resulting from the block-size limit could be utilized as a \u201chard fork insurance<\/a>.\u201d Lets say, for instance, that someone named Greg believes that bitcoin’s exchange rate will drop if the block-size limit is increased. Greg doesn’t want the bitcoin exchange rate to drop, because he holds a bunch of bitcoin. Therefore, Greg bets that if the block size is increased, the exchange rate will drop. If the block-size limit is then indeed increased, and the exchange rate indeed drops, Greg will win money. He would have effectively insured himself against that scenario. <\/p>\n

That would be an advantage for Greg personally, as he wouldn’t risk losing money. But it would also help the rest of us. After all, by making the trade, Greg has effectively stated his opinion, which is reflected in the exchange rate. Moreover, Greg could tell other people to insure themselves, or simply make his own insurance public. If people trust Greg’s expertise enough, they will follow his lead, which adjusts the exchange rate even further. <\/p>\n

But Greg is not the only one betting. Someone named Mike, who believes the exchange rate will rise if the block-size limit is increased, might be betting as well. And people who trust Mike’s expertise might follow his lead instead. Now the prediction market reflects a potentially terrific aggregate of expertise, and their expectations of what’s best for Bitcoin, offering a great guide for Bitcoin’s development. <\/p>\n

And there’s an additional bonus. Lets imagine that Greg and Mike are talented programmers, working to improve Bitcoin or the ecosystem. Thanks to the prediction market, neither Greg nor Mike need to repeatedly enter into debates on message boards convincing everyone and their grandmother that increasing the block-size limit is either bad or good. After all, they have already insured themselves, and stated their opinion through their trade. Instead of wasting their time on Reddit, they can both get back to work. <\/p>\n

No silver bullet<\/strong>
<\/h2>\n

Of course, a prediction market won’t solve Bitcoin’s governance problem in and of itself. First, since Sztorc’s Truthcoin is designed as a Bitcoin sidechain, there is one prediction that it can\u2019t support. If Bitcoin breaks completely, or its exchange rate goes to zero, no payout will be possible, even if predicted correctly. Additionally, Sztorc’s proposal relies on \u201c
oracles<\/a>\u201d
to insert the truth after an event has happened, which required a bit of trust in these oracles. (Sztorc believes we should be able to find enough reliable people to do this task, to tide us over until his larger \u201ctrustless orcale\u201d project is completed.) <\/p>\n

But, most importantly, prediction markets cannot govern Bitcoin in and of themselves. They can only advise \u2013 and maybe that\u2019s for the best. <\/p>\n

Prediction markets don’t need to replace anything. You can still have your mailing list, you can still have your forum discussions, and prediction markets won’t automatically change Bitcoin’s code,\u201d Sztorc emphasized. \u201cBut prediction markets do offer something called common knowledge. Everyone will know what the market expects to happen \u2013 and everyone will know that everyone knows. And how weird would it be if the prediction market says we’ll see a huge exchange rate collapse if we either do or don\u2019t fork to Bitcoin XT, and yet some developers still keep fighting or pushing it?\u201d <\/p>\n

For more information on Truthcoin, visit <\/em>truthcoin.info<\/a>.<\/em><\/p>\n","protected":false},"excerpt":{"rendered":"

While opinions on Bitcoin’s future differ, most agree that the current scalability debate has become a mess. Trolling, misinformation, populism, vote manipulation, vocal minorities, censorship and other distractions have made it hard to find a signal above the noise. And importantly, if protocol development is going to be driven by what seems like popular opinion […]<\/p>\n","protected":false},"author":2509,"featured_media":25693,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[34],"tags":[218,2362],"class_list":["post-25692","post","type-post","status-publish","format-standard","has-post-thumbnail","category-markets","tag-events","tag-people"],"author_data":{"id":2509,"name":"Aaron van Wirdum","nicename":"aaron-van-wirdum","avatar_url":"https:\/\/bitcoinmagazine.com\/wp-content\/uploads\/2024\/12\/aaron-van-wirdum-96x96.jpg"},"featured_image_url":"https:\/\/bitcoinmagazine.com\/wp-content\/uploads\/2024\/11\/how-prediction-markets-could-guide-bitcoins-future.jpg","_links":{"self":[{"href":"https:\/\/bitcoinmagazine.com\/wp-json\/wp\/v2\/posts\/25692","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/bitcoinmagazine.com\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/bitcoinmagazine.com\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/bitcoinmagazine.com\/wp-json\/wp\/v2\/users\/2509"}],"replies":[{"embeddable":true,"href":"https:\/\/bitcoinmagazine.com\/wp-json\/wp\/v2\/comments?post=25692"}],"version-history":[{"count":0,"href":"https:\/\/bitcoinmagazine.com\/wp-json\/wp\/v2\/posts\/25692\/revisions"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/bitcoinmagazine.com\/wp-json\/wp\/v2\/media\/25693"}],"wp:attachment":[{"href":"https:\/\/bitcoinmagazine.com\/wp-json\/wp\/v2\/media?parent=25692"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/bitcoinmagazine.com\/wp-json\/wp\/v2\/categories?post=25692"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/bitcoinmagazine.com\/wp-json\/wp\/v2\/tags?post=25692"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}