The Breakdown - The Present and Future of Crypto-Based Prediction Markets

Episode Date: November 11, 2024

A reading and discussion inspired by https://blockworks.co/news/crypto-opinion-markets-drive-collective-wisdom Enjoying this content? SUBSCRIBE to the Podcast: https://pod.link/1438693620 Watch on YouTube: https://www.youtube.com/nathanielwhittemorecrypto Subscribe to the newsletter: https://breakdown.beehiiv.com/ Join the discussion: https://discord.gg/VrKRrfKCz8 Follow on Twitter: NLW: https://twitter.com/nlw Breakdown: https://twitter.com/BreakdownNLW

Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. What's going on, guys? It is Sunday, November 10th, and that means it's time for Long Read Sunday. Before we get into that, however, if you are enjoying the breakdown, please go subscribe to it, give it a rating, give it a review, or if you want to dive deeper into the conversation, come join us on the Breakers Discord. You can find a link in the show notes or go to bit.ly.ly slash breakdown pod. All right, friends, well, today we are discussing one of the most discussed process stories around the election, which is the rise of prediction markets. Polymarket was obviously a big phenomenon in the crypto space, but even Kalshi, which the CFTC tried to shut down and was rebuffed by a federal

judge, had a big part of this story as well. The question is where prediction markets are going to fit in the future. And so to get us started, let's first turn it over to an AI me from 11 Labs to read an essay by Carl Vogel, partner at Six-Man Ventures, called Forget Polls, Crypto-Based Opinion Markets are the Future of Collective Wisdom. Here is Carl's essay. Opinions are like ass-a-hs. Everyone has one. Polls have long been the predominant method to capture public opinion and collective insight, largely because they offer a quick and scalable way to gauge public sentiment on a variety of topics. However, they are also subject to low engagement, spam, and chicanery. Just ask the UK how it ended.

up with a research vessel named Bode McBoatface. Opinion markets offer an alternative way to address the flaws in traditional polling. They can be a superior method to gauge market sentiment because they obviate the failure modes of traditional polls through blockchain-enabled capabilities like economic incentives, social credibility, and credentialing. Beyond gauging sentiment or merely wagering on the outcome of events in prediction markets, opinion markets can be used to influence the outcomes themselves. Everyone from AI agents to big brands can use them to mine insights and make decisions in a way

that is transparent, efficient, globally accessible, and highly engaging. Opinion markets are not new. One famous example is the Keynesian Beauty Contest, which was popularized by economist John Maynard Keynes. In this thought experiment, contest participants were shown photographs of people in a newspaper and asked to select the faces they believed others would find the most attractive. Participants who successfully chose the most popular faces were awarded a prize. For the sophisticated, the goal was not to choose based on individual preferences, but to predict which faces would be the most popular overall.

When applied to the stock market, one of Keynes's core insights was that participants can get trapped in an infinite loop of trying to out-predict what others will select, showcasing the challenges of investing based on market sentiment versus fundamentals. However, I posit two more insights. The polls effectively codified the UK's collective definition of beauty, and people loved playing the game. Unlike the largest opinion market in which few have an edge, the stock market, everyone believes they have an advantage in many aspects of regular everyday life, such as determining

who's prettiest. For example, who is a better match for Taylor Swift than Travis Kelsey? We all know they are an odd match. What is the best French restaurant in Manhattan? Which of these outfits is best for a first date? These are all examples of markets where certain individuals believe they have an advantage, making them more likely to participate. While the stock market represents a narrow goal of economic valuation with well-defined frameworks for valuation, for example, discounted cash flow models and PE ratios, opinion markets can have a broad range of subjects, objection functions, This, of course, creates a much more qualitative-relatable set of markets for broad appeal. Beyond the fun market examples discussed above, opinion markets represent a major opportunity

for businesses to gauge sentiment and build loyalty with their customers in a hyper-local way. For example, Starbucks could submit what street corner would be best for a new store? Netflix could ask, what should be our next city for Love is Blind? A creator may ask, what product should I review next? Today, corporations spend billions of dollars trying to identify these answers with advanced analytics teams. Opinion markets could provide a fast, and in many cases more accurate answer, while simultaneously creating direct meaningful engagement with customers.

In addition to the shortcomings of polls discussed earlier, they do not have intrinsic virality the way economic markets do. In an age of infinite content, gamification of opinion markets with economic outcomes will drive radically more engagement and virality than polls. What will these opinion markets look like? And can we trust their outputs? The wisdom of the crowd is a well-researched phenomena suggesting that collective decision-making, when aggregated, often leads to more accurate outcomes than individual judgments. Unlike traditional polls or one-off surveys, crypto-based markets offer new primitives, such as economic incentives and participation

history to increase accuracy. We don't know what the end state will be, but the most effective form factor will be determined by an explosion of research and experimentation, and the crypto advantages will undoubtedly produce better outcomes. The next generation of crypto builders will have the opportunity to create products that transform how we engage with public sentiment, forecast trends, and make decisions, both as individuals and as communities. The final question is, how will opinion markets evolve in an age of AI, where advanced algorithms can sift through massive data sets to predict social outcomes? AI agents will undoubtedly participate alongside human users contributing their data-driven insights to the mix. I think rather than replacing human judgment,

AI will compete with it to create a dynamic interplay between machine intelligence and human intuition. This will make opinion markets a unique arena for collaboration and competition between AI and human participants. Opinions are like ass-hs. Everyone has one. Does yours stink? Want to All right, back to Real NLW here. First of all, thanks to Carl for writing this and getting this conversation going. I think he brings up a ton of really interesting questions. For me, one of the things that I was really interested to observe over the course of this particular election was the extent to which prediction markets represented a more accurate representation of where things were, or if instead they represented a tool for self-fulfilling

prophecy, basically an election influencing tool. I don't know that I think that these things are mutually exclusive. My general sense is that for much of this particular cycle, prediction markets were much more about influencing the election than they were about actually pricing the chances of different outcomes. One of the other realities that prediction markets interact with is the news media's incessant need for the latest data and information. Polls can't possibly move as fast as or fill as much air as media outlets need, and so prediction markets got the boost this cycle of being reported alongside poll numbers. And indeed, they have a lot to offer in that respect. You can watch how prediction markets change during the course of a speech. That level of fidelity

at speed just doesn't exist with polls. Because of that, I think that some folks got the idea that they could juice the election in one direction by making the spreads bigger than they were in the polls. I think that for much of the end of the cycle, that's what we had going on, when Trump's odds were at something like 65% versus commonplace 35%. Now, it's important to keep in mind that all of this is in the context of what is likely to be the smallest user base that these markets will ever have. I also think that by the end of the election, particularly on election day, this was no longer the case, and it seemed to me that most of the behavior was simply about trying to arbitrage and make money, which of course is what the presumption is that that's

going to be the normal behavior. And so I think you kind of had a both and situation where some people were trying to influence the shape of the elections, taking advantage of the prediction market to media pipeline, and others were just out there trying to make money. My guess is that the more people start to use these things, the less easy to nudge them in a particular direction they'll be, and the more likely they'll just settle into their intended purpose for being a more skin-in-the-game way of assessing public opinion. In either case, I think they're a fascinating phenomenon, even if they were simply a tool for influencing elections, I still think they'd be interesting. That's my take for now, though. Big thank you again to Carl for your essay. And thanks to you guys,

as always, for listening. Until next time, be safe and take care of each other. Peace.