← Back to Academy
what-are-prediction-markets

What Are Prediction Markets?

📅 Dec 24, 2024✍️ Poly Team⏱ 15 min read

Prediction markets are one of the most powerful tools for information aggregation in the modern world. At their core, they are exchange-traded markets created for the purpose of trading the outcome of future events. Unlike traditional stock markets where you trade ownership in a company, in a prediction market, you trade the probability of a specific outcome occurring.

The Wisdom of the Crowds

The theoretical foundation of prediction markets is the "Wisdom of the Crowds" hypothesis. This suggests that the collective knowledge of a large group of people—each with different pieces of information, perspectives, and biases—is often more accurate than any single expert. In a prediction market, participants have "skin in the game." If they are wrong, they lose money; if they are right, they profit. This financial incentive forces participants to be honest and research thoroughly, leading to highly accurate market prices that reflect the true probability of an event.

How the Mechanics Work (The Binary System)

Most prediction markets use a binary share system. Each contract represents a "Yes" or "No" outcome. These shares trade between $0.01 and $0.99. The price represents the market's estimated probability of the event happening.

  • If a "Yes" share trades at $0.65, the market believes there is a 65% chance the event will occur.
  • If the event occurs (resolves as True), every "Yes" share pays out exactly $1.00.
  • If the event does not occur, the share becomes worthless ($0.00).

This simplicity allows for clear calculation of ROI. Buying at 65¢ for a $1.00 payout offers a 53.8% return if you are correct. However, the risk is a 100% loss of the principal if you are wrong.

Types of Prediction Markets

While elections and sports are the most visible categories, the architecture can be applied to almost anything:

  • Political Events: Presidential winners, legislative approvals, cabinet appointments.
  • Economic Indicators: Fed rate hikes, CPI inflation data, GDP growth figures.
  • Technological Milestones: AI model release dates, SpaceX launch successes, hardware ship dates.
  • Pop Culture & Science: Movie box office numbers, Nobel Prize winners, viral social media trends.

Why Prediction Markets Matter

Beyond personal profit, prediction markets serve a vital social function. They provide "truth-seeking" data in an era of polarized media. When a news anchor says an event is "certain," but the prediction market shows it at 40%, the market is usually correct. They are real-time, dynamic, and resistant to "expert" bias since they are governed by the harsh reality of profit and loss.