Waterhouse VC: Prediction Markets New Era

Every month, industry investors Waterhouse VC publish an article that spotlights different aspects of the ecosystem. This month, Tom Waterhouse delves into the new era for prediction markets.

As the dust settles on the U.S. election, prediction markets have captured attention far beyond traditional wagering circles. Polymarket has taken centre stage, showcasing the potential for decentralised platforms to revolutionise forecasting and betting.

Polymarket handled over $3.6 billion on wagers on the election outcome, accurately predicting not only the President but also the results in every swing state - well ahead of the Associated Press.

Prediction markets are judgement-based platforms designed to forecast the likelihood of future events. Operating on the principle of the efficient market hypothesis - the idea that market prices aggregate and reflect all available information, participants buy and sell contracts tied to specific outcomes, such as elections, sports, or economic indicators.

Typically structured as binary ‘yes or no’ wagers, the price at any given moment represents the market's collective assessment of the probability of that outcome occurring. For example, if Real Madrid are trading at 14¢ in a Champions League Winner market, it reflects a 14% chance of them winning. Price = Probable Truth.

Once an event concludes, outcomes are settled in binary form based on official results, with correct shares paying out fully, while incorrect ones hold no value.

Liquidity is lifeblood

Liquidity is essential for any market to thrive, attracting and sustaining active participation. In prediction markets, liquidity fosters a diverse ecosystem of participants - from casual speculators to informed experts. This diversity creates a robust mechanism for aggregating insights, with individual trades continuously refining probabilities in real time.

The result produces a phenomenon known as the ‘wisdom of the crowds’ effect, often surpassing the accuracy of individual expert opinions. As James Surowiecki, put it:

‘Groups are remarkably intelligent, and are often smarter than the smartest people in them’.  

Despite their potential, prediction markets rely on sustained user engagement. Historically, platforms have struggled to sustain activity beyond major headline events, limiting their capacity to provide consistently actionable insights. Without ongoing activity, markets risk stagnation, undermining their purpose as real-time forecasting tools.

Today, a new wave of platforms, most notably Polymarket and Kalshi, are looking to overcome these challenges. Both platforms have surged in popularity during the U.S election, drawing unprecedented volumes of traded contacts. While much of this activity was driven by the election, the current liquidity for other markets suggests there may be a path to a sustained role in the wider wagering landscape.

Polymarket

Founded in 2020 by Shayne Coplan, Polymarket has quickly made headlines as a blockchain-powered prediction market, allowing users to speculate on outcomes across sports, pop culture, politics and science. The U.S. election was a defining moment, with trading volumes exceeding $3.6 billion, surpassing the combined $2.5 billion in presidential campaign fundraising. For comparison, during the 2020 election (Polymarket’s first year), the platform had $10 million in trading volume on the outcome, with users accurately predicting Joe Biden’s victory.

Shayne Coplan

Coplan learnt to code as a teenager and was reportedly the youngest participant in the initial sale of Ethereum, purchasing the cryptocurrency when it traded for just 30 cents—a fraction of its current value. He studied computer science at New York University but left before graduating to pursue his interests in crypto. It was this leap of faith that resulted in Polymarket.

Advantages of Decentralisation

Polymarket operates on blockchain technology with users trading via the USDC stablecoin. This system offers instant, verifiable, and cost-effective transactions, eliminating the delays and chargeback risks of traditional card payments. For users, the platform ensures privacy - transactions don’t appear on bank statements - and avoids the fees typically associated with deposits, withdrawals, or trades.

As a decentralised exchange, Polymarket attracts a global audience and imposes no trading limits, instead it matches willing buyers and sellers of any amount. This is especially attractive to high-volume participants and underscores why liquidity is vital for a market to thrive. Smart contracts, self-executing programs embedded within the blockchain ensure transparent and automated settlements, streamlining operations and reducing costs for everyone involved.

Blockchain also provides an immutable ledger of transactions, giving users a real-time view of bets and market movements. There is also a leaderboard for trading volume and profit for individual users, which provides details on each of their trades. One standout participant has been a French speculator, identified as ‘Théo’ who reportedly earned $85 million from bets on Donald Trump’s victory.

Unlike traditional betting exchanges, Polymarket operates without jurisdiction turnover taxes, commissions, or premium charges (which often target profitable bettors). This fee-free structure creates an appealing environment for participants, providing optimal conditions for higher trading volumes and liquidity.

Prediction markets can outperform traditional guides, such polls or media analysis as they can adapt dynamically to new information, offering a more accurate and responsive snapshot of sentiment. The 2016 Presidential election highlighted the limitations of legacy information sources. The New York Times famously gave Hillary Clinton an 85% chance of winning on election morning, based on state and national polls - an assessment that failed to capture shifting dynamics.

In the lead-up to the election, Polymarket, alongside prediction platforms, Kalshi and Predictit, gave Trump a roughly 60% chance of winning, while traditional polls struggled to split the candidates.

Keeping it Simple

Wagering has always been part of the human-psyche, and prediction markets, in their simplicity cater seamlessly to this behaviour. Fractional odds set by bookmakers, while mathematically translatable to probabilities, lack the immediate clarity that prediction markets provide. This simplicity, combined with the savvy use of social media, and television appearances from Shayne Coplan have helped form a truly global community.

X, known for its opinion-driven discourse, has been particularly effective in amplifying this engagement. Regular endorsements from Elon Musk who has over 205 million followers is an incredibly powerful and cheap tool for driving users, interest and ultimately liquidity to the platform. Even Donald Trump was referencing Polymarket on X, creating a level of publicity that other wagering operators, or even any business, could only dream of achieving.

Challenges

Despite Polymarket’s position as the world’s largest prediction market, U.S. users are currently restricted from using the platform, following a 2022 ruling from the Commodity Futures Trading Commission (CFTC). Kalshi, its nearest competitor, is CFTC-compliant, but is currently only available to US residents.

Polymarket’s success has also drawn scrutiny. Following the election, the FBI raided Shayne Coplan’s Manhattan residence, seizing electronic devices including his phone, which Coplan attributed on X to the current administration, suggesting it was a means of political retribution for Polymarket’s accurate election predictions.

Mainstream Use-Case for Crypto

Backed by influential investors like Peter Thiel and Ethereum co-founder Vitalik Buterin, Polymarket has raised $70M to date. Their success underscores how great products can overcome barriers to crypto adoption. Although crypto, smart-contracts and blockchain underpin the platform, Polymarket’s simplicity, and engaging user experience were key in drawing a broader audience.

The key challenge for prediction markets will be maintaining engagement levels. Replicating the intensity of election-driven interest will be tough but with sustained effective marketing, and interesting markets to speculate on, prediction markets can have a sustained future in a wider wagering world.