Oracles of Blockchain
Gnosis, Augur and The Future of Prediction Markets
Clearly the price considered most likely by the market is the true current price: if the market judged otherwise, it would quote not this price, but another price higher or lower. — Louis Bachelier
As a child, I remember an old tree in a dusty market square whose branches were so lush they provided a shade to weary travelers. However,the same tree also provided a meeting point for people who bet on any unpredictable event such as the weather, stocks to the outcome of a game. Very similar, in my eyes, to the bullpen of a stock exchange.
Janus couldn’t have been more aptly represented and I remember my father telling me about the duality of the stock market — it provides capital (shade) to great corporations but if left unchecked,could also serve as a den of thieves. In between the two extremes lies the spectrum of human nature.
While the speculators and gamblers betting below the tree did not know the difference between stochastic and deterministic systems, they understood human nature. To me, that was the essence of behavioral economics and it was my introduction to Prediction Markets.
History of Gambling
There is an odd sense of guilt discussing gambling in the same sentence as investment and speculation. But, if you understand human nature, insider trading ceases to surprise. Investment, speculation and gambling are separated by the underlying uncertainty of events.
Gambling is almost as old as humanity and can be traced back to China around 2300 BC. Gambling artifacts have been unearthed all across the world. However, gambling was considered illegal in modern Greece. Human ingenuity, however, chases new frontiers. If there is demand, there will be a market.
The next frontier was virtual or online gambling.
Difference Between Investment, Speculation and Gambling
The speculator’s deadly enemies are: Ignorance, greed, fear and hope. All the statue books in the world and all the rule books on all the Exchanges of the earth cannot eliminate these from the human animal. — Edwin Lefevre, Reminisces of a Stock Operator.
Investing typically involves studying company and market fundamentals before placing money in an investment.
Speculation and gambling are two different actions used to increase wealth. However, the two are very different in the world of investing. Gambling refers to wagering money in an event that has an uncertain outcome in hopes of winning more money, whereas speculation involves taking calculated risk in an uncertain outcome.(investopedia)
If you haven’t already read it, I would highly recommend the timeless classic “Reminisces of a Stock Operator” by Edwin Lefevere. It is a fictionalized account of Jesse Lauriston Livermore.
Livermore was famed for making and losing several multimillion-dollar fortunes and short selling during the stock market crashes in 1907 and 1929 (source:wiki)
“Théorie de la spéculation”
The theory behind prediction markets has its roots in the random walk theory which postulates that the prices in the stock market fluctuate randomly and therefore cannot be predicted.
The concept can be traced to French broker Jules Regnault who published a book in 1863, and then to French mathematician Louis Bachelier whose Ph.D. dissertation titled “The Theory of Speculation” (1900) -(source:Wiki)
To this theoretical framework, add George Soros’ theory of reflexivity
Reflexivity refers to circular relationships between cause and effect. A reflexive relationship is bidirectional with both the cause and the effect affecting one another in a relationship in which neither can be assigned as causes or effects (source:wiki)
In other words, if people think markets will follow a certain direction, that direction becomes a self fulfilling prophecy.
Suddenly, behavioral economics becomes a subject for prediction markets.
Like I said before, my experience with the speculators under the tree is also summarized as:
Prediction markets (also known as predictive markets, information markets, decision markets, idea futures, event derivatives, or virtual markets) are exchange-traded markets created for the purpose of trading the outcome of events. The market prices can indicate what the crowd thinks the probability of the event is. A prediction market contract trades between 0 and 100%. It is a binary option that will expire at the price of 0 or 100%. (Source: wiki)
Gnosis, a Greek word loosely translated as knowledge of spiritual events, is also a prediction Market designed to run on the Ethereum platform (Blockchain).
Consider this, Gnosis raised $12.5 million in a matter of minutes through a crowd sale. Most of the investment was from outside the US.
Gnosis allows speculation on stochastic/random events or occurrences. This application has ramifications from art auctions to insurance policies, from sports betting to election outcomes, from games to the derivatives market.
Founded by Martin Koppelson and Stefan George, Gnosis aims to crowdsource wisdom and has three main goals:
Martin was the founder of the biggest Bitcoin prediction market — Fairlay.
Through collecting information by financially incentivizing good information and discouraging bad information, rather than operating like a traditional poll which would ask participants what they want to see happen, prediction markets ask what participants expect to happen. (source: crowdfundinsider.com)
As per the Gnosis blog:With the Ultimate Oracle, a market is created on “What was the outcome of this event?”. Participants can place bets on either side of the market. After the betting period, a 24 hour timer starts. If at the conclusion of the 24 hours, the outcome remains the same then the market is closed. Participants on the winning side of this market are rewarded and the other side suffers a loss. The original market is then resolved by the outcome of this secondary market.
Bets can be placed on virtually anything including GDP forecasts and election outcomes
Universal Basic Income (UBI)
Interestingly, Martin is also a supporter of UBI for all and is one of many supporters on the business of basic income platform (supporters include Sam Altman — founder of YCombinator, a former Greek minister of finance , a former US secretary of labor etc.)
As per this platform, UBI is coming sooner or later. Could the UBI be paid out in Cryptocurrency??
While speculation is under scrutiny by regulators around the globe, the spread of decentralized prediction markets holds promise. Unsurprisingly, it faces legal and regulatory challenges.
In a separate article, I will discuss a very fascinating subject ie hedge funds. But, for the sake of this article, I want you to imagine a Blockchain based hedge fund.
Smart contracts can automate all trades and management fees whereas transactions can be recorded on the Blockchain. With Artificial Intelligence, it could be the first robotic hedge fund with counterparties spread across oceans and no intermediaries.
Of course, it could lead to tremendous opacity. However, you can visualize the challenge in front of the regulators and the financial markets.
Today, Ether breached the $300 mark and Ethereum has become the next revolutionary Blockchain platform to facilitate person to person smart contracts from Tibet to Timbuktu. Make no mistake, financial markets stand at an inflection point. Risks abound but so does the promise of a new internet. Time will tell if Ether is digital gold for the future generations but the digital architects have laid out a blueprint for a bold future.
Prediction markets based on the Ethereum Blockchain such as Gnosis and Augur provide a global platform for navigating stochastic events. To me, such platforms are the tree I mentioned before.
There have been educated men who have invested in fundamentally strong companies, controlled their emotions, and amassed wealth.
Of course, control over emotions is almost always gained by making mistakes over a prolonged time.
However, as a zero sum game, there have been people who have witnessed their savings wiped off in an instant.
There is a very thin line between speculation and gambling but then, so is the line between bravery and foolishness. So tell me, my reader:
“Are you a betting man?”
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Disclaimer: This article is intended for purely academic purposes and is a personal opinion. It should not be construed for anything else.