Jsquare Report on Prediction Markets and Emerging Oracles

Understanding Prediction Markets

Prediction markets, often referred to as event derivatives, are platforms where participants trade contracts based on the anticipated outcomes of future events. The essence of these markets lies in the fact that the price of a contract directly reflects the collective judgment of participants regarding the probability of an event occurring. This mechanism enables the aggregation of vast amounts of dispersed information, allowing for collective prediction accuracy that often surpasses that of individual experts or traditional polling methods.

Typically, these contracts come in the form of binary options, where outcomes are straightforward: a set amount (for instance, $1) is awarded if an event occurs, and nothing is paid if it doesn’t. The trading price, expressed in cents, effectively represents how the market interprets the likelihood of that event materializing. One of the significant advantages of prediction markets is their ability to provide real-time odds updates, continually reflecting market sentiments as new information becomes available. This characteristic enhances price discovery across various sectors, including politics, sports, and finance.

Development History of Prediction Markets

The concept of prediction markets dates back decades, with early innovators like Betfair, established in 2000, paving the way for peer-to-peer betting on sports and political outcomes. Academic pursuits, such as the Iowa Electronic Markets initiated in 1988, played pivotal roles in validating the accuracy of these prediction systems, famously predicting U.S. election results with remarkable precision.

Over time, platforms like InTrade gained traction, becoming a favored marketplace for real-money betting on political and other events, until it was shuttered in 2013 due to regulatory pressures. The emergence of decentralized platforms like Augur in 2018 illustrated the potential for trading event outcomes without the need for a central authority, albeit with challenges like speed and usability. In recent years, user-friendly platforms like Polymarket have entered the scene, gaining popularity due to their efficient interfaces, faster transaction speeds, and lower fees. By 2024 and 2025, prediction markets began to gain mainstream acceptance, amassing hundreds of thousands of users and billions in trading volumes.

Evolution of Trading Volumes

The growth trajectory of prediction markets is stunning. In their nascent stages, such as with the Iowa Electronic Markets, investments were capped at $500, yet they demonstrated impressive forecasting abilities. Platforms in the 2000s, like InTrade, showcased robust user engagement; during the 2012 U.S. election, InTrade boasted over 82,000 users and recorded betting volumes surpassing $200 million.

In the realm of sports betting, Betfair emerged as a market leader, particularly during significant events like the 2020 U.S. Presidential election, achieving betting volumes of £4.8 billion. The rising demand for prediction markets became apparent as the trading volume for the 2020 election skyrocketed, showing an upward trend with each electoral cycle.

With the arrival of crypto-native prediction markets, trading volumes remained modest until the dawn of 2020. While Augur launched in 2018 with considerable buzz, its practical usage faced hurdles like high transaction fees and limited liquidity. The emergence of Polymarket in 2020 revolutionized the scene, with its focus on speedy transactions and enhanced user experiences. The platform’s activity skyrocketed during critical news events, peaking at a staggering $25 billion in trading volume during the November 2024 U.S. election. By the year’s end, Polymarket recorded a total trading volume of around $90 billion, cementing itself as the leading prediction market globally.

Kalshi, which received backing from the CFTC and launched in 2021, stands out by operating within U.S. regulatory compliance, illustrating a path for sustainable growth in the industry.

The Biggest Challenges Facing the Field

Despite the prominent advancements, prediction markets encounter several persistent challenges impeding their evolution into parallel standing with traditional financial markets.

Regulatory Uncertainty and Legal Barriers

Perhaps the most formidable obstacle pertains to regulatory issues. Many jurisdictions classify real-money prediction markets as gambling or unregistered financial exchanges. Early ventures often attempted to bypass such regulations through offshore operations, a strategy that has led to legal repercussions. For instance, Polymarket faced a fine of $1.4 million in 2022 and was prohibited from serving U.S. users due to regulatory noncompliance. The legal landscape is incredibly fragmented, with certain countries like the UK permitting regulated event betting while others impose outright bans. This inconsistency fosters uncertainty, causing many projects to navigate gray areas or face regional operational constraints.

Liquidity and Market Depth

Liquidity is an essential pillar for any market to establish credible probability pricing and attract participants. Most prediction markets struggle to maintain robust liquidity, especially outside of flagship events. For instance, following the major announcement of the 2024 U.S. election results, Polymarket experienced an 84% overnight drop in trading activities. Smaller markets are even more susceptible to issues such as high bid-ask spreads, rendering them unattractive to traders and vulnerable to manipulation.

Oracle and Settlement Challenges

Since prediction markets are grounded in real-world events, they necessitate reliable mechanisms to determine outcomes. Decentralized platforms have trialed different solutions, each presenting unique challenges. Augur employs a model reliant on its REP token holders for outcome reporting, which can introduce delays and potential manipulations if a malicious actor accrues significant REP holdings. Newer systems like Polymarket leverage optimistic oracles, fostering quicker settlements but still relying on trusted challengers and facing challenges with ambiguous data.

By contrast, centralized platforms often depend on internal teams or predefined news sources for outcome determination, which carries inherent trust risks.

Potential Emerging New Primitives

To address ongoing limitations, innovative prediction market projects are exploring new frameworks and mechanisms.

Prediction Derivatives Markets

The rise of derivatives markets within prediction frameworks is a promising trend. By introducing instruments that allow traders to speculate on event outcomes—similar to stock futures or options—prediction markets could potentially emulate the existing dynamics seen in traditional financial derivatives, amplifying trading volume and liquidity.

Advanced Automated Market Makers and Liquidity Mechanisms

Custom enhancements to market-making models specifically targeted at event markets are anticipated. Standard automated market makers (AMMs) often do not efficiently cater to binary prediction markets due to capital inefficiencies and slippage. New market-making models, like dynamic concentrated liquidity or advanced logarithmic market scoring rules (LMSR), are expected to be developed over time.

Interoperability Paradigms

As the prediction market ecosystem matures, interoperability with other decentralized finance (DeFi) protocols is likely to gain traction. Such interoperability could allow users to collateralize outcome tokens in lending protocols, creating opportunities for innovative structured products akin to prediction market ETFs.

Investment Opportunities in Prediction Markets

1. Derivatives Market

The establishment of a derivatives market aligned with prediction markets is poised to be an emerging trend. This encompasses perpetual contracts, options, and other leveraged instruments based on event outcomes. In established financial systems, derivatives trading often supersedes spot trading, and prediction markets are following suit.

• Gondor: A DeFi lending protocol tailored for prediction market participants, providing avenues for users to collateralize positions without liquidating their Polymarket stakes.

• D8X: A next-gen on-chain futures protocol introducing order-book-based perpetual contracts for prediction markets.

• dYdX: This preeminent decentralized exchange is also venturing into event market trading, enabling leveraged trades through perpetual contracts.

• Aura: Focused on leveraged event outcome trading, Aura allows users to make directional bet contracts through perpetual models.

• Polyindex: A protocol that permits users to create ERC-20 index tokens encapsulating multiple Polymarket event contracts.

2. Permissionless Market Creation

A paramount growth driver for prediction markets lies in the ability for users to create and trade new markets independently. This democratization of market creation fosters unparalleled innovation potential.

• Augur: This foundational protocol demonstrated proof of concept for user-generated prediction markets, enabling a variety of market types without centralized oversight.

• The Clearing Company: Established by a former Polymarket team, this initiative aims to create a regulated on-chain exchange for open market engagement.

• Melee Markets: This startup facilitates user-generated markets across diverse topics, incentivizing early engagement through viral market mechanisms.

• Kash: A protocol embedding prediction markets within social feeds, enabling quick and engaging market participation.

• XO Market: Provides a platform for instant, user-generated binary event markets, ensuring swift trading experiences through innovative architecture.

3. Prediction Market Sports Betting

Emerging challenges within the expansive sports betting market offer exciting avenues for investment. With a core user base of enthusiastic sports fans, the prediction market provides an engaging alternative to traditional sports betting.

• SX Network: This decentralized platform, evolving from Ethereum to its own chain, employs a unique betting transaction model that facilitates peer-to-peer interactions.

• BetDEX: Developed by ex-FanDuel executives, BetDEX combines the advantages of rapid, low-cost transactions with legitimate licensing.

• Aver: This Solana-based platform uses a fully on-chain order book model for enhanced betting experiences.

• Frontrunner: A dynamic sports prediction market platform adopting a stock market format for team or player shares.

• Divvy: Utilizes smart contracts to facilitate direct betting on significant sports outcomes through decentralized mechanisms.

Visualizing the Project Ecosystem

The landscape of prediction markets is intricate and evolving. Below is a visual representation illustrating the various entities, platforms, and innovations traversing this vibrant sector.

By embracing the opportunities and overcoming the challenges associated with prediction markets, the environment is set for considerable growth and profound transformation.