Defi prediction markets, explained

A prediction market enables traders to make bets on a range of future events with unknown outcomes, and are also known as “exchange-traded markets”. Think of it as a market populated by people wishing to collectively forecast the future. 

Traders buy “Yes” or ‘No” shares that reflect their beliefs about the likelihood of an outcome, such as “Will Bitcoin (BTC) be above $68,000 on November 1st”. Shares rise and fall in value as traders react to new information, such as news, polls and related incidents, pricing this into the value of the share. Unlike a betting platform, you can change your mind and close your position, assuming there is sufficient liquidity. You can even take partial profits before the event has concluded if the shares rise in value. 

Nascent versions of prediction markets have existed since the 1500s, but took a more concrete form in Wall Street in 1884, where traders wagered on the outcome of the presidential election. Today, prediction markets exist as centralized and decentralized entities, with Predictit and Polymarket being two commonly used platforms. 

While Polymarket launched in 2020, in the run up to 2024 U.S. Presidential election, it has seen huge growth in terms of volume, active traders, open interest and new accounts. 

To understand how DeFi prediction markets work, let’s examine a quick example. Several days prior to the election, traders on Polymarket believed that Donald Trump had a 66.3% chance of being the 2024 Presidential Election winner. This was reflected in the price of Trump’s “Yes” shares, which were priced at 66.3 cents. Note that this is a free market, and the price is a reflection of traders’ beliefs about Trump. While Polymarket does select which markets go live, the price of shares is always determined by trading activity.

Let’s say that you decided to back Donald Trump to win the 2024 U.S. presidency with $100. You would have received 150.83 “Yes” shares priced at 66.3 cents each. Following Trump’s election victory, your 150 shares would’ve risen to $1 each in value, representing a total gain of $50. However, had Trump lost, the shares would’ve been worthless and you would have lost your $100 investment.

Therefore, this market enables traders to express their view about the likelihood of Trump winning the election and this methodology is applied to a range of different topics. 

Traditional sports books differ from prediction markets in a few ways:

• When you back a horse or team to win at a bookmaker, you are effectively betting against the house. The sportsbook in question sets the price, and you can either take it or leave it. The bookmaker is not incentivized to offer you value in the price, and their own traders use historical data and modeling to ensure that outcomes are priced with a long-term negative expectation, after factoring in their margin. 
• Conversely, prediction markets are made of traders betting against other traders. The platforms hosting these markets play no role in setting the price, but are responsible for settling bets and distributing winnings. 
• Bookmakers tend to primarily focus on sports events, while prediction markets offer a much broader range of markets for traders to speculate on. 
• Bookmakers select which markets they will offer, while at Polymarket, anyone can suggest a market, which will then be considered by the platform. 

While at the time of writing, the U.S. Presidential election is dominating volume and mindshare, it is just one of many highly-diverse prediction markets. 

To demonstrate this, below is a selection of prediction markets taken from two popular DeFi platforms:

• Manifold: Will we reach "weak AGI" by the end of 2025?
• Manifold: Who will post the most-liked tweet of 2024?
• Manifold: Will the Apple Vision Pro be successful enough to revive interest in mixed reality and the metaverse?
• Polymarket: Highest grossing movie in 2024?
• Polymarket: How many Fed rate cuts this year?
• Polymarket: Will the US confirm that aliens exist in 2024?

The most popular markets of 2024 unsurprisingly relate to the looming Presidential election:

1. Presidential Election Winner 2024, Polymarket, $2.9b traded. 
2. Who will win the 2024 US presidential election? Predicit, $42m traded. 
3. USA - Presidential Election 2024 - Election Winner, Betfair Exchange, £121m matched. 
4. Who will win the Presidential Election? Kalshi, $139M traded. 
5. Will Trump win the 2024 Election? Manifold, $120k traded. 

NB: All figures quoted above were recorded on 01/11/24.

To understand the potential impact of DeFi prediction markets, it’s essential to weigh both sides: the benefits that make DeFi prediction markets attractive to users and the drawbacks that could limit their growth.

Decentralized platforms have a host of benefits over their centralized counterparts:

• Transparency: Because platforms like Polymarket operate using blockchain technology, all transactions are indelibly recorded on a ledger, which users can review and personally audit at any time. This open book approach may foster greater trust, as there can be no doubt that markets are settled correctly, and any concerns can be easily highlighted and addressed. 
• Accessibility: Defi prediction markets are generally more globally accessible and do not require any KYC,  enabling traders from all over the world to converge on one platform. This arguably allows for greater collective wisdom, meaning that prices may be a more truthful reflection of likely outcomes. However, following a settlement with the CFTC, US residents are not allowed to wager on Polymarket, so the degree to which it is accessible depends on local regulation. 
• Freedom of expression: Unlike Predictit, which has an $850 cap on each contract, traders on Polymarket can bet as much as they like. In fact, the current Polymarket leaderboards shows that many traders have in excess of $100m of volume. Enabling traders to express their view without limitation, which again may create markets that are a greater reflection of reality. 
• Reduced fees: Some centralized platforms charge as much as 10% of your profit as a fee, and an additional 5% on every withdrawal. Polymarket does not have any fees per se, but does profit from the spread between the bid and ask price of their markets. 
• Open, code-driven execution:  Because much of the code adopted by decentralized platforms is open-source, anyone can vet how their smart contracts work. In addition, once an event has concluded, the same smart contracts ensure that winnings are swiftly and correctly distributed to traders without delay. One additional benefit of this is that DeFi prediction markets never take custody of your funds. They are always held in a smart contract which can be viewed at any time.

With all that being said, decentralized prediction markets have some notable flaws which should be taken into consideration:

• Volatility: If you are betting on the price of cryptocurrency, you should be mindful of the inherent volatility and how quickly a market can turn against you. As with all trading activities, risk should be managed carefully, to ensure you never lose more than you can afford to.
• Manipulation: Because some DeFi platforms don’t have the same limitations on who can participate or how much you can wager, it stands to reason that larger players could potentially move a market in their favor if they had enough capital. It was recently suggested that one particularly large French trader was behind several large bets on Donald Trump.
• Unexpected Twists: Sometimes, it can be very fine margins that determine the outcome of a market, resulting in huge swings and significant losses over a very short period. In September 2024, one market with over $500k in volume was concerned with when the Eigenlayer Foundation would launch their token. For the "Yes" traders to win, the Eigen token needed to launch by 11.59pm Eastern Time on September 30. In a painful twist, the project announced the token’s launch would take place at 9.00pm Pacific Time, just one minute after the required deadline. This sent the value of the "Yes" shares down to 3%. However, because the token launched a few minutes earlier than planned, the market actually resolved with the "Yes" traders winning, marking a miraculous reversal and rollercoaster outcome.
• Centralization: DeFi platforms such as Polymarket are not completely decentralized in a couple of important ways. While anyone can suggest a market, it’s ultimately the Polymarket team that selects which markets go live. Second, the outcome of each market (and therefore who wins and loses) is determined by the Polymarket team, and some decisions are not clear cut and require some discretion. All traders are ultimately vulnerable to the platform correctly classifying the outcome of the event, and there can be challenging edge-cases.
• Biases: Research has shown that prediction markets more generally are susceptible to biases that in some cases can lead to markets being significantly over or under priced. 

Here’s some basic steps that will help you participate in prediction markets if you wish to do so:

1. Select a Platform: Choose a reputable DeFi prediction market based on factors such as supported markets, fees and usability.
2. Connect a Wallet: Most platforms require a Web3 wallet, such as MetaMask, to interact with the markets and manage funds.
3. Explore Market Options: Browse available markets, from elections to sports, and select an event you wish to wager on.
4. Place a Bet: Buy shares in the outcome you believe is most likely, and confirm the transaction.
5. Track and Redeem: Follow the event in real-time. When it concludes, smart contracts automatically process winnings for accurate predictions, with funds sent directly to your wallet.

For more information, check out our Kraken Learn Center guide, What is a Web3 Wallet

Decentralized prediction markets offer a novel way to create markets and bet on the outcome of future events, and have a range of benefits over the centralized equivalent.

Leveraging the advantages of blockchain technology, DeFi platforms are cheaper, more transparent, more accessible and have fewer constraints for users.

While these platforms carry their own unique risks, the recent spike in demand shows that traders are seeking an alternative to legacy platforms that have existed in some form for many years. 

Looking for a place to trade prediction market cryptocurrencies? Kraken gives clients access Gnosis (GNO), Drift Protocol (DRIFT) and many other prediction market tokens at the click of a button.

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