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Crowd Wisdom - The Missing Ingredient in Prediction Markets

Crowd Wisdom - The Missing Ingredient in Prediction Markets

How can investors benefit from the decentralization of investment platforms

Crowd Wisdom - The Missing Ingredient in Prediction Markets
Crowds — the collective group of people with a common interest — is a powerful thing.

If you have a question about a specific topic, who are you best to ask: a recognized expert or John/ Jane Q. Public?

Well, if you have a question about what's going to happen next in the wild world of financial markets, you may get more accurate predictions by asking a group of ordinary people than from an economist, analyst or even the CEO of Goldman Sachs. The idea that the masses can make surprisingly more accurate collective judgements than expert individuals, is nothing new.

Power in Numbers

James Surowiecki's 2005 book "The Wisdom of Crowds" compellingly illustrated how crowd wisdom works.

Let's travel back to 1906, when Charles Darwin's cousin Francis Galton, a Victorian polymath, was the first to note the wisdom of the crowds at a livestock fair.

In one event, fair-goers were given the opportunity to guess the weight of an ox. The person with the closest guess to the actual weight would win a prize. Galton pointed out that the average of all the entries in a ‘Guess the Weight of the Ox' competition at a country fair was amazingly accurate — beating not only most of the individual guesses but also those of alleged cattle experts.

This is the essence of the wisdom of crowds — their average judgement converges on the right solution.

Now let's look at prediction markets, an area that stands to benefit greatly from crowd wisdom and which, to date, has been largely dominated by an elite few advisors and investors.

Many people are daunted by trading, but predicting is ubiquitous in our daily lives. We are a tribe of, what I like to call, "homo-predicens", The concept of "homo-predictions" refers to how humans predict in everything we do. Predictions are the basis for our most trivial expectations such as me expecting the words to appear on the screen as I type them.

Analytical predictions are the professional backbone of analysts and brokers in the stock markets. However, what separates predicting from guessing is knowledge.

"Large groups of people are smarter than an elite few" according to Surowiecki, and this is just as relevant to prediction markets as it is to any other facet of daily life.

Disparity of information

When it comes to financial trading, typically, trades take place on an exchange market or in an Over-The-Counter (OTC) contract where they are orchestrated by market makers.

These market conditions are where the asymmetry of crowd wisdom is fully felt. Two parties make the trade, but just one is privy to crowd wisdom. Much like the livestock fair Surowiecki examined, the farmers purchasing the oxen, like ordinary investors, make predictions in isolation, without access to information about which way their counterparts to the trade are leaning. Let's explore this a little more.

Currently, all data on who is selling and buying what, and when, is solely held by brokers and market makers alone. This represents a distinct asymmetry of information.

These centralized providers overlay the information from historic volatility prediction models, and augment it with crowd wisdom. Each new contract signed is factored into the pricing of the next contract.

However, the traders themselves don't have this key information on how others are predicting. Without access to the same information and analytic tools, the individual trader remains at a disadvantage, relying on their own siloed resources. This information blackout also enables institutions to market certain products to offset their potential losses by pricing them attractively, another way in which they use their advantage over the investor to create unfavourable market conditions for them.

Now, let's go back to that livestock fair in 1906. It should be clear by now that, as with any trade where only one party knows exactly what everyone else is estimating, the advantage lies solely with that party. In collectively guessing the weight of the ox, all the participants gain an advantage.

Surely, there is something we can learn from this and apply to the investing world? It is time to take the ox by the horns and employ crowd wisdom to bring about a fairer and more equal distribution of wealth.

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Written By
Vaibhav Kadikar
Founder, CloseCross - Decentralized derivatives driving democratic participation

The products offered by the Company are complex in their nature and not appropriate for everyone. You may lose some or all of your money. Read our Risk Information and Terms of Use for more information on associated risks.