Tokenizing Prediction: On-Chain Binary Options with Polymarket
During FTX’s heyday, binary options were offered for the Trump vs. Biden presidential race, encouraging people to bid on the ultimate winner. Moving into 2024, on-chain prediction markets like Polymarket are gaining traction, becoming a notable feature of the upcoming U.S. presidential election. While Trump continues his campaign for the presidency, Biden has stepped down, leaving many questions to Harris.
Prediction, Options, and On-Chain Options
Let’s start by delving into predictions and options. A prediction market is a financial tool where people trade contracts based on the outcomes of future events, with prices reflecting collective forecasts. For example, in the 2024 U.S. presidential election prediction market, Trump holds 59% chance of winning, while Harris holds 39%.
The election results are based on reports from the Associated Press, Fox News, and NBC. The market concludes once all three sources declare the same winner. If one of the sources declares a different winner by inauguration day (January 20, 2025), the market will settle based on who takes the oath of office.
Binary options focus on the “binary” nature of outcomes, predicting whether an asset’s price will be above or below a specified level at expiration, giving a simple yes or no answer. Thus, prediction markets make markets on event outcomes, while binary options predict asset prices. Polymarket can be seen as a combination of both, using smart contracts to automate operations.
The Evolution of Prediction Markets and Blockchain
The integration of prediction markets and blockchain started around 2017, with Augur being a notable early project. Launched in 2017, Augur allowed anyone to bet on anything. However, it faced scalability issues, as it was built on Ethereum, leading to high gas fees.
Despite using decentralized verification to ensure result accuracy, Augur’s complex process impeded onboarding new users. Specifically, the verification system requires a randomly selected group of nodes, similar to a jury, to verify the results. If a second randomly selected jury agrees with the challenge, the nodes providing incorrect information lose their margins. While this process theoretically produces reliable results, it is extremely complex in practice, leading to longer processes.
Moreover, Augur became controversial for facilitating illegal activities, like betting on assassinations and terrorism, due to lack of regulation, severely damaging its reputation.
Polymarket, learning from Augur’s lessons, targeted mainstream events like the World Cup, EURO 2024, and Trump’s 2024 campaign, successfully entering the mainstream.
What Did Polymarket Do Right?
From the outset, Polymarket addressed compliance to prevent illegal operations. To minimize complexity and enhance user trust, the new prediction market simplified smart contract design and added transparency measures, like clearly recording transaction histories and verification processes.
Most importantly, Polymarket chose Polygon over Ethereum to reduce gas fees. To address liquidity issues, Polymarket adopted various strategies to enhance liquidity, such as attracting more participants and diversifying market types, thereby improving market stability and predictability.
Founded in 2020, Polymarket initially relied on an AMM mechanism to provide liquidity for specific prediction events. Users could bet using USDC purchased with debit or credit cards without directly holding cryptocurrencies or storing private keys, lowering entry barriers and enhancing usability.
Polymarket’s architecture runs partially on-chain, while order matching runs off-chain, optimizing performance and reducing transaction costs and delays, ensuring security and transparency but with some compromise compared to Augur’s fully on-chain solution.
Additionally, Polymarket incentivized liquidity providers (LPs) with unique reward plans by setting near-market orders. The closer the order price to the market average, the higher the rewards, encouraging large order placements for potentially higher rewards.
Polymarket’s popularity surged with Trump’s involvement, leading to a product mechnism more akin to Web2, avoiding an overemphasis on Web3 elements. Polymarket partnered with MoonPay, enabling users to place bets using debit and credit cards, enhancing convenience.
Additionally, Polymarket gained significant attention from the prediction market. After surpassing $265 million in total bets on the election, renowned prediction market analyst Nate Silver joined Polymarket, boosting its industry influence and recognition.
With 30,000 monthly active users and daily trading volumes stable at $10 million, Polymarket received substantial VC support, securing at least three funding rounds totaling $74 million.
Following Polymarket’s success, prediction market products proliferated across blockchain platforms. Various chains launched their own prediction products, like Polkamarkets, Oracula, Venue.one, Diviner Protocol, and even traditional DEXs like Pancakeswap introduced similar products, showcasing the popularity.
Conclusion
While on-chain prediction markets have begun to attract traffic, their market size remains small compared to other sectors like DEXs. They show significant volatility tied to the U.S. elections. Other markets, such as sports betting, have not seen the same level of success. This is because sports betting is already a well-established market where traditional competitors offer deeper liquidity and a wider variety of options.
Nevertheless, on-chain prediction markets are a financial tool with significant potential for large-scale expansion beyond DEXs. If they can gain mainstream attention, particularly with the ongoing Trump phenomenon, they could find a viable path to success and growth.
