Every time you enter a contract where you have to buy something in the future, you are entering a ‘futures contract.’ Where you agree to sell an item in the future because you think it will be more valuable, that’s a prediction market. Lately, prediction markets have been on the rise in both stocks and cryptocurrencies, and different investors have had divergent opinions.
How Prediction Markets work
In the stocks and commodities industry and even with Bitcoin as well, prediction markets are standardized. Each prediction contract made is specific to all the parameters involved. In a typical prediction market, the contract must specify the following:
- The unit being traded
- How the settlement will be made
- The currency to be used
- The quality of items being traded and the amount being traded
In the cryptocurrency sector, futures have been changing the way investors approach the cryptocurrency. Prediction markets allow investors to predict Bitcoin’s prices without even owning it. While this may be good news for traders who want to avoid the hassles involved with owning the cryptocurrency, it lowers Bitcoin’s liquidity.
Cryptocurrencies naturally increase in value as their demand goes up. However, if investors are able to invest in a coin without ‘physically’ owning it, this means that Bitcoin is actually not having increased adoption.
Do Prediction Markets Affect Cryptocurrencies Negatively?
Bitcoin prediction markets became popular late in 2017 after the Chicago Board Options Exchange (CBOE) introduced the concept on their exchange. One day after the announcement, Bitcoin’s price surged by 10%.
Within two weeks, top cryptocurrency exchanges like GDAX, Kraken, HitBTC, and Bitstamp also introduced prediction markets, driving Bitcoin’s value upwards to hit an all-time high of $19,000. When the futures contracts matured, something expected happened: Bitcoin’s value dropped by 72% within the first two weeks of January 2018, settling at $6,000.
Today, Bitcoin’s price is valued at the same range it was prior to the introduction of futures, $7,700. The introduction of prediction markets may have driven Bitcoin’s value upwards, but the price later underwent a market correction.
Although prediction markets affected Bitcoin’s price and a correction later happened, forces other than futures seems to have more impact on the price of Bitcoin. Read this article to learn more about prediction markets in the cryptocurrency industry.
Effects of Prediction Markets in General
Short-term Rise in Value
One of the most consistent changes noticed after the introduction of prediction markets in any industry is that the value of commodities involved increase suddenly. When gold futures were introduced in 1974, the price surged from less than $300 for a kilo of gold to $400 in just three months. Three months later, gold’s value went down again, probably because people dumped the asset.
In nearly all markets, the introduction of futures almost always leads to more demand for the commodity. However, after investors sell their futures contracts, a market correction occurs.
Demand for Commodities
Prediction markets may be a specialty of the experienced investor, but they always tend to drive demand for commodities to a great extent. Investors love to make predictions, and if they are certain they could make money out of it, they will purchase the commodity involved.
Bitcoin, for example, was valued at just above $7,400 when rumors emerged that the Chicago Board Exchange would introduce Bitcoin futures. Within a week of the rumors, Bitcoin’s value had risen to more than $10,000. Many institutional investors, who previously have always been wary of cryptocurrencies, quickly adopted the cryptocurrency.
With extremely high demand for any product comes a market correction. This has occurred and reoccurred in different stock markets, commodities and with Bitcoin as well. Last year, when Bitcoin moved from just $7000 to $19000 in one month, its price suddenly moved down to $6000 in the next 30 days.
If today a cryptocurrency exchange announces that they will offer prediction markets for a less popular coin like Zcash, its demand will suddenly increase. However, once they buy contracts and they mature, the coin’s value is likely to go back once again, leading to huge profits or losses to those on the wrong side of prediction markets.
Greater Convenience for Investors
Prediction markets are a breath of fresh air for many investors. For one, futures are conducted in the most convenient manner for investors. If the markets are made for commodities like gold, investors only need to sign contracts using their cash. They don’t have to own physical gold to enter futures contracts.
With more investors feeling confident about trading, demand for the commodities definitely increase. In the long term, prediction markets tend to improve the liquidity of commodities and assets. However, as studies have often shown, they don’t have a great impact on any industry on their own. Traditional forces of demand and supply have the biggest impact on the prices of commodities and digital assets.
Like most financial instruments, prediction markets keep on evolving. In sports and casino gambling, it’s now possible to make predictions of live events so that your contract matures within minutes or hours. For example, you can bet the outcome of a basketball game while it happens.
In the blockchain industry, prediction markets are evolving by eliminating the intermediary companies. Instead of making predictions on a website, different investors can predict the outcome of games, events or market prices directly on a blockchain platform. Their funds are held by smart contracts, and winners get their rewards automatically after the outcome of the event is determined.
One of the most underrated impacts of prediction markets is their ability to influence people’s decisions. If a market asks people to bet against the outcome of a football game and 70% of the investors predict team A will win, other investors are likely to place the same bet.
If 80% of investors make a prediction that certain crypto will drop in value, a lot of investors are likely to short sell the same coin because of the influence of prediction markets. On a broader scale, prediction markets have always been used as the benchmark of making financial decisions by lots of companies, governments, and investors.
Prediction markets, like any financial instruments, may have an impact on trading markets from time to time. However, on their own, these markets don’t have such a huge impact as to affect the long-term price movements of stocks, assets or commodities.
This blog post was written by our guest, Ronny Martelli from Exposureland.com