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What Do Prediction Markets Say For Crypto Post-FTX? A Meta-Analysis.
What do betting markets forecast for the future of highly speculative markets?
Intro Pt. 1: Crypto and The Wisdom and Madness of Crowds
Making predictions about crypto is pointless, but it's also fun. In theory, analyzing cryptoassets should be straightforward. Most companies (that aren't FTX) openly promote their development roadmaps with community input, and transactions are displayed on an open ledger for optimal transparency. For example, I can tell you how many transactions Ethereum (a blockchain) processed yesterday, but I can't do the same for Stripe (a startup).
And yet somehow, crypto prices have greatly surpassed any basis of fundamental value. In October this year, Token Terminal (Bloomberg for crypto stuff) featured valuation data for the top 114 tokens. These top-tier projects had an aggregated market cap to annualized revenue ratio of 200:1, remarkably higher than traditional private or public equities. So somehow, assets offering the benefit of near-perfect information are predominantly composed of speculative value. It's weird.
Evaluating (or attempting to evaluate) cryptoassets is less a financial modeling exercise and instead a crash course in the wisdom of crowds and madness of crowds. These phenomena are opposing interpretations of group intelligence. Large groups either produce good predictions (the wisdom of crowds) or mass hysteria and financial ruin (irrational exuberance and the madness of crowds). In reality, both theories have merit and heavily depend on focus area.
The wisdom of crowds proves useful for:
User-generated content (Yelp reviews, Airbnb ratings, Amazon ratings, IMDB ratings).
The field of machine learning.
Price equilibriums when there is perfect competition and perfect information.
The wisdom of crowds morphs into irrational exuberance in certain situations, like:
The 2008 financial crisis.
Gamestop and meme stonks.
Dogecoin and meme coins.
Pets.com and dot-com stocks.
You'll notice most cases of irrational exuberance involve financial speculation. Interpret that however you want.
Intro Pt. 2: Prediction Markets to Forecast Speculative Markets
Prediction markets (also known as betting markets) exemplify the wisdom of crowds in its purest form. For those who don't know, prediction markets are open exchanges where participants are incentivized to forecast the outcome of a given event.
The most common market type is a binary options market, where you can buy in on an outcome (yes or no) at a certain percentage likelihood. From there, your purchase functions much like a traditional stock, increasing its value toward 100% or losing value and eventually hitting 0%. You can sell your purchase for a gain if your chosen market likelihood appreciates, and vice-versa as it relates to losses.
Take Polymarket's prediction market for Volodymyr Zelenskyy winning "Time Person of the Year" as an example:
As you can see, "yes" and "no" options each possess market values, denoted in cents, which cumulatively sum to $1. Last week I could have bought $100 of "yes" shares at 68¢ - since the market believed this outcome was 68% likely. When Zelenskyy wins (which I assume he does not give a shit about it, given he is fighting a war), the value of my 68¢ "yes" shares increases to $1, and my $100 investment becomes $147. Zelenskyy gets to be on the cover of a magazine, and I get $47. Sounds like a win-win.
Prediction markets have proven accurate in forecasting the outcome of uncertain events (elections, sports, economics, etc.). There is an expanding literature on betting market efficacy ( thanks tofor compiling these links). Here are a few examples:
For whatever reason, there are numerous prediction markets for cryptocurrency (because gambling on gambling is fun).
There is something beautiful about markets for speculating on highly speculative markets - it's almost too meta. These crypto prediction markets will serve as the basis of our analysis.
Key Questions: Where Next?
Our meta-analysis will examine current prediction market outlook and contemplate cryptocurrencies' future, both for the industry and me.
Question #1 - Where Does the Crypto Industry Go From Here?:
Crypto media has a saying that the industry trades on narratives (which makes sense given a high degree of speculation). Prices ebb and flow based on ever-changing projections of future web3 utopia. Well, today, crypto feels far from that utopia. The industry is soul-searching following the collapse of FTX and the ensuing market contagion. So what is crypto's next chapter? And what is the new narrative?
Question #2 - Do I Still Want to Follow this Industry?:
Typically, I remove myself from these articles as much as possible. But this piece quickly became a Rorschach test for my crypto fascination. I should be clear my interest does not lie in token investing. I've never thought of blockchains as means of financial liberation. I had a small portion of my portfolio in cryptoassets, but divested when the FTX news broke. Instead, I follow the space like a spectator sport. There is so much energy, innovation, and drama, all at max velocity with never-ending turbulence. It's like following The Amazing Race, Formula 1, or Squid Game - but with coders and VCs. However, the FTX debacle has prompted considerable introspection. And as I wrote this piece, I kept asking myself - do I want to dedicate future mental energy to this industry? And why is crypto so captivating, despite its countless flaws?
Methodology: Creating Narratives from Prediction Markets
Our analysis will focus on four themes and the narratives expressed in their corresponding prediction markets. Our themes are:
The conclusion of the FTX saga.
Crypto mainstream adoption.
What fails next.
Murder and other fun stuff.
Prediction Market Sources:
We’ll use markets from the following sites:
Polymarket: Polymarket is a decentralized web3 prediction market that allows you to bet tokens on the outcome of current events. You can make actual money using Polymarket, and, as a result, the project cannot operate in the U.S. due to regulatory pressures.
Manifold Markets: Manifold Markets is a play money prediction market with user-created questions. The play money can be redeemed as a charitable donation. Anyone can pose a question on Manifold. It's controlled chaos, and I love it.
Metaculus: Metaculus is an online forecasting platform and aggregation engine working to improve human reasoning and coordination on topics of global importance. Rewards are reputation based; the site heavily concentrates on altruism and human welfare.
Our selected markets will not feature price predictions. This isn't CNBC.
Our selected markets will have a minimum of 25 participants. This number is arbitrary and was not derived through statistical rigor. I will stray from this threshold if I find a market particularly important (or funny).
Our selected markets will showcase current forecasts for a "yes" outcome and a categorical confidence level based on the number of participants or trading volume. These labels provide a directional approximation of significance but are (again) not statistically rigorous.
Our selected markets will highlight predictions transcribed on Wednesday, December 7th.
Narrative #1: The FTX Saga's Conclusion
The FTX collapse is a story that simply will not die. The rapid disintegration of Sam Bankman-Fried's crypto juggernaut sits at the nexus of considerable public fascinations: crypto schadenfreude, white-collar crime, effective altruism, people dunking on effective altruism, drug abuse, weird Twitter behavior, public contempt for billionaires, feuds between robber barons, polyamory, disgraced political donors, and so much more. This story will live on in the public consciousness for some time, much like Enron or Bernie Madoff.
SBF's Future: According to our highlighted markets, Sam Bankman-Fried will be charged at some point next year and convicted before 2026. Participants also forecast he'll be in jail for six and half years, which is generous compared to Elizabeth Holmes' eleven-year sentence. What I found most intriguing about SBF's scandal markets is the non-trivial likelihood he'll escape legal action, at least before the dates specified in our resolution criteria. Current market equilibriums indicate a ~20% possibility Sam Bankman-Fried avoids criminal charges. I'm afraid I have to disagree here. SBF eviscerated $10B in wealth, defrauded Silicon Valley elites, and is accountable to over one million creditors - I struggle to believe he'll avoid repercussions. But then again, I am but one potential market participant, so what do I know?
FTX Arena: FTX Arena (the stadium where the Miami Heat play) is a year-old relic of crypto's gilded age. Unsurprisingly, renaming a stadium takes some time. Manifold markets assign a 24% likelihood of an arena name change before the end of the year. Will professional sports forbid future crypto sponsorships? Probably not - money is money, and people have short memories.
Effective Altruism Fallout: One of the great tragedies of the FTX saga is its association with the effective altruism movement. For those who don't know, effective altruism is a philosophical and social movement that advocates "using evidence and reason to figure out how to benefit others as much as possible." Effective altruism (or EA) receives significant funding from tech billionaires, most notably SBF, and focuses heavily on efficient resource allocation and utility tradeoffs in philanthropic giving. In August this past year, Vox published a sprawling overview of the EA movement and christened Bankman-Fried as de facto poster boy. But it gets worse. In February of 2022, Sam Bankman-Fried established the unfortunately-named FTX Future Fund to distribute his entire fortune across various EA causes. Over the past few weeks, there has been considerable speculation about whether EA leaders knew of Bankman-Fried's fraud and to what extent. Manifold traders believe there is a 70% chance that effective altruism leaders were ignorant of SBF's impropriety, which is surprisingly low. Furthermore, the FTX contagion may spread to the charities themselves, as Metaculus participants assign a 38% likelihood of a funding freeze or clawback. What a mess. If you want to see a chart that will make you sad, here is the Metaculus market on whether SBF would make good on his promise to donate $1B (created before FTX's insolvency).
Narrative #2: Mainstream Crypto Adoption
More regulation is coming, and it's not all bad. Apart from that, forecasters are pessimistic about crypto adoption by governments and corporations, while NFT enthusiasm remains strong.
U.S. Regulation: There is widespread belief that The Digital Commodities Consumer Protection Act (DCCPA), a bill for which SBF lobbied heavily, should pass in the next year or two. This bill would bring much-needed regulation to U.S. crypto markets. Imagine a world where you can utilize web3 without fear of fraud, rug-pulls, bank runs, hacks, opaque ponzi-nomics, embezzlement, or instantaneously losing all your life savings. That would be cool. Furthermore, a slim majority of forecasters believe the SEC will approve Bitcoin ETFs, allowing everyday consumers to purchase cryptoassets through traditional financial intermediaries (Schwab, Fidelity, etc.) instead of doing so via crypto exchanges (Coinbase, FTX, etc.). So now your uncle or grandma can buy Bitcoin - which is what we all want.
International Regulation and Adoption: Forecasters predict continued cryptocurrency restrictions in China and minimal worldwide adoption of digital currencies in state-sponsored commerce. Currently, El Salvador is the only country that encourages Bitcoin as legal tender. Let's hope they bought the dip.
Adoption by Corporations: Unsurprisingly, corporate America is willing to wait on crypto adoption. Amazon is unlikely to accept Bitcoin any time soon, and Walmart probably won’t issue a digital currency. There is a non-trivial contingent of forecasters who believe Twitter may incorporate Dogecoin on its platform. I think Twitter has other issues to address, but anything's possible at Twitter 2.0.
Paying U.S. Taxes with Bitcoin: I don't know if (or why) anyone wants to do this. But if you do, then my apologies, as this seems unlikely. How would paying taxes in an ever-fluctuating currency (relative to the dollar) even work? If Bitcoin dips as you're wiring the money, do you have to file a second time?
NFTs to the Moon: Despite chaos in financial markets, participants seem optimistic that an NFT could sell for as much as $144M, equivalent to ~12,000,000 real-life Chipotle burritos. I don't buy into the NFT hype, but I also used to collect colorful pieces of cardboard featuring pictures of baseball players (known as baseball cards), so what do I know?
Narrative #3: The Next Implosion
My takeaway from the past year is that anything can implode at any time. Perhaps twenty years from now, the long-departed crypto craze will be nothing more than a case study in business school textbooks. Or maybe crypto wealth will rain from the skies once the "bear market" fades. I don't know anymore. But it's clear nothing is safe; maybe all crypto projects carry a +10% chance of insolvency for the foreseeable future. But I guess that may come with a 10% chance of life-changing fortune, so it's a matter of risk tolerance.
Big Players are Still at Risk: Forecasters believe Genesis and Crypto.com are at significant risk of implosion. If Crypto.com goes bankrupt, the LA Lakers would need to rename their stadium, and we'd presumably witness the end of crypto stadium sponsorships. Meanwhile, Genesis, an institutional crypto brokerage, was forced to suspend lending redemptions following FTX's collapse. Genesis recorded $50B worth of loans in 4Q 2021 and is oft-considered a Berkshire Hathaway or Goldman Sachs equivalent for the crypto industry. A Genesis collapse would be very bad for crypto, though I'm not sure what "bad" means anymore. Coinbase also carries some insolvency risk over the next few years (comparatively less than Crypto.com or Genesis), though perhaps that's just base-case for crypto companies nowadays.
A Stablecoin Could Collapse: Stablecoins are digital currencies pegged to non-digital money. In most cases, stablecoins are 1:1 with the U.S. dollar. One coin attempts to equal one dollar. It sounds simple, and yet stablecoins implode constantly. Stablecoin failures are particularly cruel, given they're marketed as ultra-sound financial instruments - and then explode. Markets believe Tether, crypto's largest stablecoin, carries a 25% likelihood of collapse in the short-term, with a potential failure sometime in early 2023. If this were to happen, crypto would probably die its final death.
Narrative #4: Murder and Other Fun Stuff
The FTX story will never die. Love live FTX. In fact, SBF's incompetence/malfeasance/polyamory will be immortalized by Michael Lewis, which sounds like misinformation but is the truth. A crypto founder won't get murdered, but we can't say for sure - a 12% probability is close for comfort.
Crypto Murder: Many influential crypto founders formulate an almighty cult of personality, fashioning themselves as gigabrain outlaws preaching the gospel of decentralized liberation. Founders with a penchant for self-aggrandizement frequently produce unsound financial products and spectacular internet content. Such theatrics foster equal parts blind devotion and fantastical animosity. People lost their life savings due to the collapses of FTX, Terra/Luna, Celsius, Blockfi, Voyager, and Three Arrows Capital - and that's just this most recent cycle. It's feasible that an unlucky retail customer could seek vigilante-style retribution.
Michael Lewis' Next Great Book: The author behind Moneyball, The Big Short and The Blind Side spent six months with SBF in the run-up to FTX's collapse. You can't make this stuff up. We may live in a simulation, specifically the timeline where Michael Lewis achieves great fortune. There is debate over the title of the upcoming book (and likely movie). My vote is for "Atlas Rugged."
Elon Musk: Could cement his status as meme king by somehow putting a Dogecoin on the moon.
FTX Sex Stuff: One of the more colorful storylines emerging from the FTX debacle regards the sexual behavior of FTX and Alameda Research leaders. Sam Bankman-Fried and Caroline Ellison (head of FTX sister firm Alameda Research) were romantically involved, as were many other people tasked with running the multi-billion dollar crypto empire. As such, the term "polycule" has gone mainstream. For those who don't know, a polycule is a connected network of people in non-monogamous relationships. Now you know.
Here is google trends data for the word "polycule" over the last five years:
Final Thoughts: What Now?
Where does the industry go from here? And where do I go from here?
Prediction markets, while not entirely dire, forecast further volatility and risk. Markets currently indicate a 10% to 40% likelihood of another major collapse (Tether, Crypto.com, Coinbase, Genesis). Plus, the disgrace of FTX, no matter how comical at times, likely set mainstream adoption back years (or forever). The only certainty is industry regulation and volatility. So why is crypto so appealing? And why do I still enjoy following the space?
Let's return to the wisdom and madness of crowds. James Surowiecki, who coined the term "wisdom of crowds" in his book of the same name, also outlines conditions in which groups produce poor collective judgment. Surowiecki argues that in certain situations, members of crowds are overwhelmed by the opinions of others and eventually conform. He highlights five criteria that distort markets:
Homogeneity: the need for diversity to ensure variance in approach, thought process, and private information.
Too Centralized: People's opinions must be independent of those around them.
Division: All market participants need to operate with similar information.
Imitation: Where choices are visible and made in sequence, an "information cascade" can ensue. People will imitate others they perceive as successful or correct.
Emotionality: Emotional factors, such as a feeling of belonging, can lead to peer pressure, herd instinct, and in extreme cases, collective hysteria.
Unsurprisingly, some of these conditions impact crypto markets.
And yet, despite these distortive influences, I believe the crypto industry will produce worthwhile tech - if only because so many talented individuals are building in web3. Markets can be irrational, even when the underlying asset has worth. Much of crypto's weird market behavior lies in a mismatch between current and expected value. Today, crypto is underwhelming in tangible value, but one day it might be critical infrastructure that expedites our day-to-day existence. Throw in the fact that these experimental startups are traded like public equities and that people are getting rich off these bizarre financial instruments, and it all gets very confusing.
If the range of outcomes is zero dollars, infinity dollars, or ponzi scheme - that makes for a captivating asset and fodder for prediction markets. As of now, I select crypto prediction markets over actual cryptocurrency investing; it's gambling without the threat of a bank run. But then again, I am but one potential market participant, so what do I know?
I once heard a VC exclaim that "crypto is the best game in town." I agree with this person; crypto is a highly entertaining game. If you're still in the crypto game, then good for you, but it's a game I can no longer play. So instead, I'll be on the sidelines watching and forecasting.
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