by Joe Ellis
Imagine if you could accurately predict the future; be able to Google questions for which the answers are not yet known and get tangible results. Augur, a decentralized prediction market, might just allow us to do this. Exploiting a scientific principle known as the ‘wisdom of the crowd,’ Augur could offer a level of clairvoyance never seen before.
What is a Prediction Market?
Before we delve into the details about Augur, it is first necessary to understand what a prediction market is. In essence, a prediction market is an exchange-traded market created for the prediction of the outcome of events. In allowing traders to buy and sell shares in the outcomes of events, the market prices are indicative of what the crowd believes the probability of some episode occurring is.
2011 research suggests that prediction markets are at least as reliable as institutions who predict the similar outcomes privately and independently through some pool of experts.
These markets rely on the predictive accuracy of a collective, which is usually a sound estimate due to a conjecture known as the wisdom of the crowd. The underlying meaning of this principle is that, given input from a large enough population, the average answer across the group tends to be far more accurate than that of any one expert or small pool of experts. It is this notion that allows us to create accurate forecasting tools, where we can create confident predictions for future outcomes and act upon them accordingly.
The Market For Prediction Markets
Prediction markets might seem like a gimmick, but rest assured they are very valuable. By harnessing the wisdom of the crowd, we can acquire accurate predictions of the future. Ultimately this will lead to more efficient markets. Google have used internal prediction markets in the past to gauge the potential for success of new products. Employees were invited to bet ‘Goobles,’ an imaginary currency, on various outcomes.
These markets could remodel many aspects of the financial system, too. For example, prediction markets regarding corporate behaviors, such as acquisitions, changes in management and earning reports, could be used as a form of hedge.
Last but not least, a prediction market has the potential to aid those living in developing countries who do not have appropriate instruments to hedge against financial, political or even climate related risk. Where insurance is not available, somebody living in an area prone to flooding might purchase a prediction contract which pays out if there is a flood.
What is Augur?
Augur is the self-titled ‘future of forecasting.’ Currently in beta, it is a decentralized prediction market whereby participants are rewarded for their knowledge, insight, and ultimately their ability to predict future events.
As is the case for many other industries where blockchain technology is flourishing, the fundamental problem with existing prediction markets is that they are centralized. This carries many heavy burdens, not limited to how the market can easily be shut down, manipulated or compromised. Powerful governments and special interest groups have shown distaste towards prediction markets in the past; InTrade, for example, was an Irish company shut down by the U.S. Commodity Futures Trading Commissions. As stated in the Augur whitepaper, where powerful interests want to shut down a service or website, they will find a way.
Of course, another facet for abuse in centralized prediction markets is that there is a single person disseminating the true outcome of an event, jeopardizing the integrity of the entire process. This authoritative figure is susceptible to making mistakes, where the true outcome of an event is published incorrectly by accident; being blackmailed, allowing for a collective or cartel to manipulate the market; and defamation, where the market’s health could be impacted by a substantial hit to the reputation of its administrator.
Augur is decentralizing a platform for prediction markets. With Augur, anybody can create a market asking a question about absolutely anything; sporting events, election results, and even the gender of a celebrity baby. The market creator asks a question, and once the market is open thousands of people can purchase shares in outcomes of events.
Augur’s whitepaper details the philosophies underpinned by the project, as well as explaining how the platform will work. Augur is built as an extension to the Bitcoin Core codebase. This is because the codebase offers necessary ingredients to create an effective prediction market, as well as allowing Augur to capitalize on the security and stability of the Bitcoin blockchain.
Augur intends to use a pegged sidechain approach to guarantee interoperability with the Bitcoin blockchain. A pegged sidechain permits the exchange of assets between two separate blockchains. At a high level, this happens by creating a transaction which ‘locks away’ some cryptoasset on the first blockchain, then creating another transaction on the second chain whose input makes reference to the first transaction with a proof that the lock has been applied correctly. These proofs are tagged with an asset type, which is usually given by the genesis hash of the asset’s corresponding chain.
Augur makes use of three cryptographic coins: bitcoin, ether and Augur’s own ERC20 token ‘reputation’, abbreviated to REP. Augur’s current settlement currency is ether, meaning that betting on the outcome of an event is facilitated through the Ethereum blockchain. Bitcoin enters the equation by virtue of the aforementioned pegged sidechains, allowing traders to use bitcoins to bet as an alternative to ether. REP is used as a reputation system among the people who report the ground truth and is not used for betting.
The Forecasting Period
The advancement of a prediction market can be split down into two key phases: before and after the occurrence of an event. The former is called the ‘forecasting phase,’ and the latter the ‘reporting phase.’
Ethereum smart contracts enable users to create any predictive marketplace to ask any question. The creator of the market provides some initial funding, then receives trading fees from the investors who purchase shares in an outcome. The so-called ‘trading fee’ is, to all intents and purposes, a transaction fee that’s used as an incentive structure for the contributors to Augur.
Without bogging ourselves down in the details, creating a prediction market is as simple as specifying a question, a type (i.e. binary yes/no, numeric, categoric, etc.) and a maturation (duration of the forecasting phase). The creator pays a small fee for the creation of their market, as well as some initial funding for the sake of liquidity.
Once the market is created, investors are free to purchase shares in the outcomes of events.
The Reporting Phase
After the event has occurred and the forecasting phase is complete, we enter the reporting period. REP holders are strictly obliged to report the outcomes of randomly selected events within Augur every time the network ‘checks in with reality.’ By default, the rate at which this occurs is every eight weeks, though this interval is variable. People who report ground truths are incentivised to do so with trading fees in the market. Trading fees are split 50-50 between the owner of the market and the reporters.
The reporting period is split into a further two phases. At the start of the reporting period, reporters are assigned markets for which they must provide ground truth for. As it currently stands, they are allotted 30 days to produce a report. In this 30 day period, reports from reputation holders are securely and privately submitted to the network using a cryptographic commitment scheme. Preceding this, the reveal period commences, in which the reputation holders publish their reports in plain text for all to see. The reveal period takes 29 days to complete. After the reveal period, consensus is reached, and the ground truth outcome is established.
The wagers are then paid out to the shareholders who made the right prediction. Additionally, reputation holders who reported the established truth are awarded 50 percent of the trading fees for their honesty.
Reporters who failed to disclose the outcome of an event accurately, reported/revealed late or exhibited dishonesty is penalized; the system redistributes their reputation amongst the holders whose reports reflected reality. Reports are weighted by reputation; in principle, the more REP you hold, the more reliably your reports are perceived, and as a consequence the larger the proportion of trading fees you receive when you report the ground truth.
The Augur REP Token
Augur REP is a digital token representing the reputation for each participant in the Augur network and is one of the largest tokens on top of Ethereum’s blockchain. Similar to other tokens such as GNT, REP is a limited-supply token with a cap of 11 million REP. All of these tokens were created during the Augur ICO. 80 percent of the total supply was sold to investors (8.8 million REP), where the remaining 20 percent (2.2 million REP) was divided between Augur’s developers and the Forecast Foundation in a 16-4 percent split. In this ICO, the Augur team raised $5.3 million in funds.
You do not have to own any REP to use Augur. In fact, the majority of Augur users will never use REP. As mentioned earlier, bets are placed using bitcoin and ethereum.
It is important to mention that REP is not intended to be a stable source of value, but rather an essential component to the Augur platform. REP is used exclusively by the users who report the true outcomes of events. As its name suggests, it literally is ‘reputation’ among those who report ground truths. The Augur team make it clear: “REP is a token that comes with both responsibility and reward; it is not a currency.” Contrary to this statement, REP does have real monetary value because its availability is the only way to access 50 percent of all trading fees within the Augur network. As mentioned earlier, the proportion of the total REP you possess equates which proportion you own of all of the trading fees within the network, so unmistakably the REP token will have real monetary value. However, investment in the token could be considered a very heavy risk at this point. Some people predict that trading fees will be around one percent. This means that 0.5 percent of all volume within the Augur network goes to reporters, since they receive half of the trading fees. This has a direct bearing on the market price for the REP token; at this point, it is hard to determine the market potential for predictive markets and as a result the market capitalization for REP is uncertain.
Since it is estimated that trading fees will comprise one percent of Augur’s total volume, and it currently stands that trading fees are divided evenly between reputation holders and market creators, REP holders therefore collectively own 0.5 percent of all market fees. The total 11 million REP tokens represents 0.5 percent of trading fees, therefore, if you own N REP, you are entitled to N / 22,000,000 of all of the market fees within the Augur network (accounting for the remaining 0.5 percent that goes to market creators).
REP can be in two states; dormant or active. All reputation begins dormant, and when you decide to activate your REP, you are obliged to report ground truths. If your REP is active and you do not report on your assigned markets for over a month, you will be penalized 20 percent of your reputation holdings, and your account will automatically be made dormant. Dormant REP is not subject to penalty, but it does not receive trading fees and cannot be used to report.
The Long-term Outlook for REP-USD
Participants are incentivized to act honestly, as if a large proportion of REP holders are dishonest, no one will want to use the platform. The weekly price action of REP-BTC is shown below and illustrates the structure of the market. After reaching a high at 0.01600000 against bitcoin, REP started to retrace and test Fibonacci support levels. The market currently stands above an important level at 0.00591782, however, there could be a full 100 percent retrace to the fractal support 0.00370014. Also, an important support at 0.004000000 may also slow REP’s decline to an inertia before reversing. Immediate resistance lies at the 38.2 percent retracement level at 0.00728978.
The Awesome Oscillator is still positive but is red in color. A move below zero will indicate strengthening bearish momentum and in this case, we would look for a test of the fractal supports before buying REP.
Augur offers a better alternative to centralized prediction markets. The technology has great potential, opening such markets to the general public and allowing everyone to prosper. The opportunities are significant, and the technology has the potential to transform many industries; marketing, financial services and gambling are the ones which immediately spring to mind.
In decentralizing the market, a culture based on honesty and integrity is cultivated. Good actors are rewarded for their truthfulness and bad actors are penalised for misconduct. These principles allow the market to flourish in good character.
History has proven the efficacy of prediction markets. In a decentralized model, we can only expect better results.