The 2024 League of Legends World Championship saw T1, seeded fourth from Korea, advance to the finals. Fueled by the global fanbase of star player Faker, T1 dominated pre-tournament polls as the favorite to win. Their victory on November 2nd solidified Faker’s status as potentially the greatest of all time (GOAT), and marked T1’s fifth World Championship title (2013, 2015, 2016, 2023, and 2024), an unprecedented achievement and the only team to win back-to-back championships.
Table Content:
- Prediction Markets: Bridging the Gap Between Forecast and Outcome
- Challenges to Accuracy in Crypto Prediction Markets
- Personal Bias: Skewing the Odds
- Market Size, Liquidity, and Manipulation
- Time Horizon: A Double-Edged Sword
- Hedging: A Necessary Evil with Unintended Consequences
- Prediction Markets: Valuable Tools, But Use with Caution
Around the same time, the US presidential election was heating up, impacting both traditional and crypto financial markets. Polymarket, a prominent prediction platform in the crypto space, displayed a significant advantage for Trump, with red states representing over 62% compared to Harris’ blue states. However, did this accurately reflect the sentiment of the American populace? This raises a critical question about the reliability of prediction markets, echoing the disparity between pre-tournament predictions and the final outcome of the League of Legends World Championship.
Prediction Markets: Bridging the Gap Between Forecast and Outcome
The examples of T1’s victory and the Polymarket predictions highlight a crucial point: popular sentiment doesn’t always align with reality. This discrepancy is inherent in prediction markets.
Prediction markets, long established in traditional finance with platforms like PredictIt and Metaculus, allow participants to wager on future outcomes across various domains – sports, politics, finance – to gather information and forecast trends. While valuable for information discovery, they don’t guarantee accurate predictions of real-world events. Just as T1 defied expectations, prediction markets often diverge from actual results.
Learn more: What are Prediction Markets in Crypto?
Challenges to Accuracy in Crypto Prediction Markets
Several factors contribute to the difficulty in maintaining accuracy within crypto prediction markets.
Personal Bias: Skewing the Odds
Individual biases can significantly distort prediction market outcomes. Participants often overestimate the likelihood of events aligning with their personal interests or strong emotions. For instance, a Chelsea fan might place a disproportionately large bet on their team winning the Champions League, even if the true probability is lower.
The Polymarket data during the US presidential election provides a clearer illustration. Trump’s (YES) odds were consistently higher on Polymarket compared to other forecasting platforms like Metaculus or PredictIt. This likely stemmed from Polymarket’s user base, predominantly crypto investors potentially more inclined towards Trump due to his perceived crypto-friendly stance. This bias skewed the market away from reflecting true probabilities.
Image Source: Prediction Market
Efficient markets self-correct for discrepancies. However, when participant bias significantly influences outcomes, the market struggles to rebalance probabilities accurately. This raises questions about the reliability of prediction markets as forecasting tools in such scenarios.
Market Size, Liquidity, and Manipulation
Consider the presidential election prediction markets on Polymarket. Dune analytics indicated around 30,000 active wallets during the peak in late October, while SimilarWeb reported 16.2 million website visits in September. These figures suggest a relatively small user base compared to the 341.8 million US population. Consequently, predictions might not accurately represent the broader American public’s opinion.
Furthermore, Polymarket utilizes an AMM (Automated Market Maker) pricing mechanism, known for lower capital efficiency and susceptibility to manipulation. Low liquidity means a relatively small capital injection, even a few tens of millions of dollars, could potentially manipulate the market and distort odds. This vulnerability undermines the reliability of predictions.
Image Source: Polymarket
Time Horizon: A Double-Edged Sword
Prediction markets function effectively when odds accurately reflect the true probability of events. However, market efficiency isn’t always straightforward. When a market exhibits a slight bias but the event’s resolution is distant, the potential profit might not incentivize players to correct the market. A 1% discrepancy in a market resolving in six months offers a meager 2% annual return, insufficient compared to risk-free rates in traditional finance.
This scenario applies to major financial events like Federal Reserve (FED) interest rate decisions on Polymarket. If the market predicts a 50% chance of the FED maintaining rates, and a minor rumor shifts the odds to 51%, correcting this requires investing in the opposite outcome. However, with the meeting months away, a 1% profit over such a duration might not justify the risk.
Image Source: penntoday
In such cases, adjustments occur only when:
- The discrepancy becomes large enough to incentivize risk-taking.
- The time to resolution shortens, reducing risk and increasing potential profit.
Hedging: A Necessary Evil with Unintended Consequences
Hedging, a common risk management strategy, can skew prediction market probabilities. To mitigate risk from a large position, traders might bet on the opposite outcome in a prediction market, altering odds without changing the event’s true probability.
For example, a trader buying $1 million in SPY call options anticipating an interest rate cut might hedge by placing a $200,000 bet against a rate cut on Polymarket, shifting the odds from 50/50 to 48/52. While an efficient market should correct this, several factors hinder this process:
- Low Frequency and High Risk: Unlike a coin toss, FOMC meetings occur only 12 times annually, increasing the opportunity cost and risk for market correction.
- Information Asymmetry: Other traders might suspect the “NO” buyer possesses insider information, deterring them from correcting the odds. This illustrates how prediction markets are influenced by factors beyond pure probability.
Prediction Markets: Valuable Tools, But Use with Caution
Prediction markets offer invaluable real-time insights and odds. However, relying solely on them for probability estimations can be misleading. Biases, time horizons, and hedging demonstrate that these markets don’t always accurately reflect true probabilities. In complex events, incorporating a margin of error and integrating insights from other sources – social media, news articles, and expert analysis – are crucial for a comprehensive understanding. While promising as a “go-to” tool for Web3 users and investors, prediction markets require cautious interpretation, acknowledging their inherent limitations and potential risks.
