Author: Matías Andrade Cabieses & Tanay Ved Source: Coin Metrics Translation: Shanooba, Golden Finance

Key Points:

• The prediction market provides real-time, market-driven insights into event probabilities, offering a more dynamic alternative to traditional polling methods.
• Polymarket has become one of the most widely adopted prediction market platforms, built on Polygon Layer-2 Blockon-chain. It has accumulated over $200 million TVL and consumed 25% of the gas on Polygon.
• The 2024 U.S. presidential election market of Polymarket has gained huge attraction, and the return of BTC shows a moderate positive correlation with election odds, indicating intermittent connection between cryptocurrency and political sentiment.

Introduction

Traditionally, opinion polls guide decisions in areas such as political predictions and consumer behavior. However, due to concerns about bias and lack of transparency, traditional opinion polling methods and mainstream media face increasing scrutiny. In this context, prediction markets like Polymarket have emerged as a noteworthy alternative. By leveraging digital infrastructure and public Blockchain (in the case of Polymarket), these platforms achieve market-driven real-time predictions, capturing collective wisdom - qualities that have sparked great interest in prediction markets, especially on the eve of the 2024 US presidential election. Polymarket is now at a unique crossroads, where political outcomes and market sentiment are intertwined with the dynamics of digital assets.

In this article, we delve into how Polymarket's prediction market operates on Polygon and analyze the data behind the 2024 presidential election market to understand the potential impact on digital assets.

What is prediction market?

Prediction market is a platform where users can buy and sell 'contracts' for the outcome of future events. Similar to exchanges where participants buy and sell stocks of listed companies, prediction market enables users to trade based on the probability of specific events occurring. These events range from the champion of the English Premier League to the next Intrerest Rate adjustment by the Federal Reserve. The price per share is usually expressed as 'yes' or 'no', reflecting the overall probability of the event happening, and prices will adjust based on new information and changing sentiments. Unlike traditional opinion polls that provide valuable but instantaneous public opinion snapshots, the uniqueness of prediction markets is that they can dynamically reflect information from a multitude of domains.

The concept of prediction market can be traced back to several years ago when various modern platforms emerged, from Kalshi and PredictIt to Augur and Polymarket. While they share a common goal of harnessing collective intelligence to predict outcomes, they differ in underlying technology, decentralization level, accessibility, and regulatory status. However, recently, Polymarket has become one of the most widely adopted prediction market platforms, leveraging blockchain technology to achieve global accessibility, transparency, and low-cost settlement.

How does Polymarket work?

Architecture Overview

Polymarket's core is a blockchain-based prediction market that leverages the Polygon Layer-2 network. It allows users to purchase 'shares' representing different outcomes of future events. The platform operates as a hybrid on-chain application, with some components located off-chain to support larger-scale transactions, while Settlement is done on-chain in a non-custodial manner.

Polymarket uses a Central Limit Order Book (CLOB) to facilitate trading between ERC-20 collateral assets (currently only USDC) and Gnosis Conditional ERC-1155 assets (Multi-Token standard). In practice, the user's USDC collateral units are split into binary outcome tokens ('Yes' or 'No'), maintaining a market price equal to one collateral unit. Users can also acquire these tokens through direct trading on the order book or interacting with the AMM Liquidity pool. 'Operators' are responsible for matching, ordering, and submitting trades to the exchange for on-chain settlement participants.

Polymarket also integrates with UMA protocol's Oracle Machine to determine the correct outcome of events. In case of disputes, UMA Tokenholders will vote to decide the final resolution. This hybrid approach combines the Polygon network, Gnosis Conditional ERC-1155 Token, an off-chain order matching CLOB, and UMA protocol's Oracle Machine. Compared to purely on-chain solutions, Polymarket can operate with higher scalability and performance. With recent momentum, Polymarket has accumulated over 2 billion Total Value Locked and contributed to over 25% of gas consumption on Polygon.

Understanding the events, markets and odds.

The core of Polymarket is events, markets, and odds, which work together to keep the system running smoothly. Event refers to the specific outcome that users are trying to predict, also known as a question. These outcomes can be political events (such as election results) or real-world events (such as weather or sports match results). Market is the platform where users can bet on potential outcomes of these events.

Polymarket provides two types of markets:

1. Single Multiple Outcome Market: These markets allow users to bet on multiple possible outcomes of a single event. For example, which movie will be the highest-grossing film in 2024? The results include the names of multiple movies, such as "The Incredibles 2" or "Deadpool 3", with the total probability of all outcomes adding up to 100%.

2. Binary Market: The structure of these markets is a simple 'yes' or 'no' proposition, and users can only bet on one of the two possible outcomes. For example, 'Will the price of Bitcoin exceed $68,000 on November 1st?'.

Users deposit USDC as Collateral into the Polygon network to participate in these markets, which are split into binary outcome Tokens representing the positions of 'yes' or 'no' for the events. Users can trade these Tokens through centralized limit order books or on-chain AMM Contract Trading, where the Token prices (or 'odds') reflect the collective assessment of the market's probability for each outcome. As market conditions change, the Token prices also fluctuate, allowing users to adjust their positions.

Once the event is resolved, anyone can propose a solution using UMA by issuing USDC bonds, and if the outcome is undisputed, they can receive a reward. During the challenge period, when there is a dispute over the event outcome, UMA Tokenholders will vote to decide. Poorly worded markets may lead to such disputes, such as the recent event regarding whether the Israeli army will invade Lebanon. After the event is resolved, the owners of winning outcome tokens can trade them one-to-one for USDC Collateral, while losing outcome tokens become worthless.

2024 Presidential Election Market Outlook

Political categories, especially the '2024 presidential election winner,' have always been the market with the highest volume and most active on Polymarket. As of October 28th, the market has accumulated a total volume of $2.5 billion since its inception. The stock prices (or odds) of each candidate fluctuate greatly throughout the year, capturing changes in public opinion and market sentiment as real-world events unfold.

Trump's chances of being elected hovered around 50% at the beginning of this year, and have risen to over 65% in recent months, while Harris's chances have risen after Biden withdrew from the race in July. Given Trump's pro-cryptocurrency stance, analyzing the relationship between candidate probabilities and BTC prices can reveal the potential correlation between political and cryptocurrency market sentiment.

Due to the price of BTC basically being in a state of Fluctuation throughout the year, the relationship between it and the likelihood of Donald Trump winning on Polymarket is currently unclear. However, they exhibit consistent periods, especially during major trend reversals—such as Trump pumping over 50% in May, dropping below 70% in July, and recently climbing to 65% in October.

As shown below, the 30-day rolling correlation between BTC returns and odds changes provides a clearer picture. From May to August, Trump's odds showed a moderate positive correlation with BTC returns (peaking at 0.4), while Harris' odds exhibited a weaker, usually negative correlation, reflecting people's perception of her stance on digital assets. Recently, both correlations have approached zero, indicating that although there is a short-term relationship, the long-term prospects of BTC are currently unrelated to the success of the two candidates. Instead, the market may be waiting to take decisive action after the election results, and global factors such as monetary supply are driving BTC's broader trend.

Looking Ahead

As a widely used blockchain-based prediction market, Polymarket has gained undeniable attention due to its role before the election. However, it also faces certain challenges in dispute resolution and regulatory review. Against the backdrop of rising odds for Trump's victory, the platform has recently been accused of market manipulation by a 'Whale'. It seems that the cause of this dispute is a user controlling four accounts, totaling $46 million in election bets. It is worth noting that other prediction markets and polls also show similar trends. Although this does not indicate market manipulation, Polymarket as an offshore platform may continue to face regulatory obstacles. However, a recent favorable ruling for the U.S. prediction market Kalshi by the courts may provide a precedent.

As the 2024 US presidential election enters its final stages, it remains to be seen whether Polymarket and similar platforms can maintain their dominant position in decision-making. However, they have clear and unique advantages, providing dynamic, transparent, and market-driven 'sources of truth' that complement traditional models and proprietary data. The election results may further validate Polymarket's predictive capabilities and its value in making informed decisions.