Once viewed as an experiment at the fringes of finance, prediction markets have moved closer to the mainstream, where platforms like Polymarket allow people to bet on real-world outcomes. From elections and sports to pop culture, prediction markets enable users to earn profits by correctly predicting the future. Beneath the speculative thrill lies a more profound question: can prediction markets sustain engagement outside peak events like elections, or are they inherently cyclical, spiking in periods of heightened media attention?
Polymarket's performance during the 2024 U.S. election was remarkable, with 20 million website views, $300 million in trading volume, and over 1 million concurrent users. The platform's open interest reached a record $463 million on Election Day, marking a 40% increase from the previous week.
Cumulatively, Polymarket has processed over $3.5 billion in trading volume related to election outcomes.
These figures underscore a significant public demand for trading in prediction markets. However, can they be relied upon and are they sustainable?
Prediction markets are not a new phenomenon. The concept of financial speculation on uncertain outcomes traces back to the Iowa Electronic Markets [IEM] in the late 1980s, which allowed participants to wager on U.S. election results. By aggregating insights from traders, IEM offered forecasts that were often more accurate than traditional polls, providing a model for prediction markets as powerful information aggregation tools.
Since then, prediction markets have struggled to gain a stable foothold, facing regulatory challenges, low liquidity, and difficulty achieving significant adoption. Platforms like InTrade and PredictIt emerged as early leaders but ultimately failed. InTrade, a pioneer in geopolitical and financial predictions, became a media sensation before closing in 2013 due to regulatory pressures and liquidity challenges. Its downfall revealed a fundamental truth about prediction markets: they are vulnerable without regulatory clarity and robust liquidity.
PredictIt faced similar barriers. While it pioneered political prediction markets in the U.S., regulatory pressure from the Commodity Futures Trading Commission [CFTC] forced it to shut down in 2023. This regulatory action dampened the prediction market community, as PredictIt was a model for legally compliant, event-based trading. Polymarket, however, bypasses many of these issues by operating as a decentralized, on-chain platform, showcasing crypto’s potential to deliver transparent and open prediction markets.
Prediction markets operate on a simple yet profound principle: they aggregate collective intelligence by allowing participants to bet on uncertain events. Each trade is a market-based expression of probability, producing a dynamic forecast that reflects the beliefs of a wide range of participants. This approach, rooted in the “wisdom of the crowd,” capitalizes on the insight that, collectively, a diverse group’s opinions can yield accurate predictions.
In Polymarket’s setup, participants use stablecoins, typically USDC, to place bets on various outcomes. These outcomes are binary: winning bets receive a payout if the predicted event occurs; if it doesn’t, the losing bets expire worthless. Unlike traditional betting platforms, Polymarket functions as a neutral exchange, enabling users to trade with one another directly rather than with the platform. This decentralized structure allows open, peer-to-peer trading, sidestepping the legal constraints that traditional betting platforms face.
Polymarket’s architecture depends on UMA’s decentralized oracle for outcome verification. In this context, an oracle is a data source providing real-world information to smart contracts, thereby ensuring accurate, transparent results that aren’t prone to manipulation. However, reliance on third-party oracles introduces risks, highlighting a core challenge in decentralized prediction markets.
Prediction markets are effective because they leverage free markets' principles as efficient information aggregators. In a free market, each participant has “skin in the game,” which motivates them to invest only when they believe in their position. The resulting balance of opinions, shaped by financial incentives, yields a more reliable approximation of event probabilities than traditional methods, where biases or external agendas can influence public statements.
Prediction markets align with ‘Hayekian information theory’, where free markets are regarded as sophisticated information processors integrating knowledge dispersed across individuals. Unlike polling, which relies on stated beliefs, prediction markets incorporate financial stakes, making them less susceptible to bias. By encouraging participants to put capital behind their beliefs, prediction markets create price signals that reflect real conviction, providing a form of forecasting rooted in economic theory.
Yet, this doesn’t make prediction markets immune to flaws. As evidenced by Polymarket’s need for consistent liquidity, a well-functioning market must balance a diverse range of participants. When liquidity is limited, markets are more vulnerable to manipulation by “whales” or groups of traders capable of moving prices, compromising their role as reliable information sources.
Polymarket breaks from the traditional exchange model by avoiding transaction fees altogether, opting instead for a frictionless, accessible trading environment that aligns closely with crypto’s decentralized ethos. Rather than monetising directly from trades by taking a cut of the stakes or winnings, Polymarket relies on an indirect approach focused on strategic partnerships, potential sponsorships, and community-driven incentives. This model allows Polymarket to cultivate a loyal, engaged user base while sidestepping conventional fees, positioning itself as a platform rooted in community ownership. This strategy prioritises growth and engagement first, laying the groundwork for future monetisation through avenues like token incentives and external collaborations, creating a more inclusive and sustainable ecosystem.
Polymarket’s fully on-chain structure gives it a distinct regulatory advantage and provides its users with an unmatched level of transparency. By decentralizing the marketplace, Polymarket mitigates the regulatory risk that centralised predecessors like PredictIt and InTrade faced, positioning itself as a secure and censorship-resistant alternative.
Polymarket and other prediction markets face significant challenges, especially around liquidity. Sufficient trading volume and open interest are essential to creating an efficient market and ensuring prices reflect real probabilities. With sufficient liquidity to balance opposing views, prediction markets can avoid being swayed by well-capitalised players or coordinated groups, whose trades can distort market prices and erode credibility.
In August 2024, for instance, a group of traders accounted for over 23% of Polymarket’s daily volume on bets related to the U.S. election, highlighting the risks of concentrated market power. When a few players dominate trading, prices may reflect their interests rather than the crowd's collective wisdom.