The Rise of Prediction Markets in Crypto

Prediction markets have emerged as one of the breakout applications in the current cryptocurrency cycle, with platforms like Polymarket gaining significant traction and media attention. These markets allow users to speculate on the outcomes of various events, from political elections to sports results, by buying and selling shares representing different outcomes. As the 2024 US Presidential election approaches, interest in prediction markets has surged, with trading volumes reaching new heights.

In this episode of Unlayered, hosts Sal and Dave sit down with Kyle DiPeppe, CEO of Hedgehog Markets, to discuss the company's bid to become the largest prediction market in the crypto space. Hedgehog, built on the Solana blockchain, aims to leverage decentralized technology to offer competitive advantages over traditional betting markets and establish itself as a major player in the prediction market ecosystem.

Hedgehog's Journey in the Crypto Space

Kyle DiPeppe's entry into the world of prediction markets was somewhat serendipitous. He joined Hedgehog when it was still in its early stages, working at a VC incubator. Initially taking on an operational role, Kyle eventually took over leadership of the project when the original founder decided to pursue a Ph.D.

The journey hasn't been without its challenges. During the crypto bear market, Hedgehog experimented with different models, including a free-to-play polling mobile app. However, with the resurgence of interest in Solana and the approaching US election cycle, Hedgehog returned to its roots in classic prediction markets.

Kyle explains: "We kind of went back to our roots, which were classic prediction markets and started putting up some markets in November, December and really went heavy starting in January and saw that there was some interest, especially going into an election year."

Understanding Prediction Markets

Prediction markets operate on a simple premise: users can buy and sell shares representing different outcomes of an event. These shares are typically priced between 0 and 1, with the price representing the market's assessment of the probability of that outcome occurring. If an outcome occurs, the corresponding shares pay out $1 each, while shares for other outcomes become worthless.

What sets prediction markets apart from traditional betting platforms is their dynamic nature. Prices fluctuate based on trading activity, providing real-time insights into the perceived likelihood of various outcomes. This feature has made prediction markets increasingly popular as a source of information for journalists, analysts, and the general public.

Kyle highlights the appeal of prediction markets: "I think prediction markets in the sense of a binary option style, where there's sort of a resolution or an outcome, are in a way easier for non-crypto native people to also grasp, which is why you see polymarket getting cited for the odds of an event happening."

The History of Prediction Markets

While prediction markets have gained prominence in the crypto space, their history predates blockchain technology. Kyle provides some context:

"I predict it was one of the more non-crypto prediction markets that were available. And they kind of found a little loophole to operate within the US, at least for a period of time. And more recently have kind of had to not allow US participation anymore."

In the traditional finance world, regulated prediction markets like Kalshi have emerged, offering a more conventional approach with CFTC approval and KYC requirements. In the crypto space, platforms like Augur paved the way, though they faced challenges related to usability and settlement times.

Hedgehog's Approach to Prediction Markets

Hedgehog differentiates itself through its focus on permissionless, on-chain solutions for market creation, participation, and resolution. The platform currently offers classic prediction markets with an AMM (Automated Market Maker) style, allowing users to freely trade yes and no shares up until the market's closing date.

Kyle elaborates on Hedgehog's vision: "We are aiming to create a fully permissionless and on chain way to create, participate, and resolve markets. So we really don't want to, like, have ownership of any of that flow at, at, you know, our end goal."

To address some of the challenges inherent in prediction markets, Hedgehog is exploring alternative market types:

1. Pooled Predictions: Similar to parimutuel betting in horse racing, where all bets are placed into a pool and payouts are determined by the proportion of winning bets.

2. Pooled Parlays: Allowing users to make multiple predictions in a single bet, with payouts increasing based on the number of correct predictions.

3. P2P Markets: Enabling direct peer-to-peer betting between users.

These new market types aim to solve some of the issues around market creation and resolution that have plagued traditional prediction markets.

The Challenge of Market Creation and Resolution

One of the key challenges in prediction markets is ensuring that markets are created with clear, unambiguous terms and resolved fairly. Kyle explains the difficulties:

"Right now the hard part with market creation, if you do follow prediction markets, there have been quite a few Polymarket markets that have been very contentious when they've been getting resolved just due to ambiguity or how people are interpreting the resolution criteria."

To address this, Hedgehog is exploring market structures that allow for easy invalidation and refunds if a question proves ambiguous or impossible to resolve fairly. This approach aims to reduce disputes and improve user trust in the platform.

The Oracle Problem in Prediction Markets

Resolving prediction markets accurately and fairly is a crucial challenge. Many platforms, including Polymarket, use an optimistic oracle system where anyone can propose a resolution, which is then subject to potential disputes.

Hedgehog is developing its own optimistic oracle on Solana, which would allow third parties to resolve markets. However, Kyle acknowledges that this approach is not without its challenges:

"You could basically attack the protocol itself because if you have enough money, you could buy enough tokens to just vote in the way that you want the outcome to go rather than how the outcome should go."

To mitigate this risk, Hedgehog is considering maintaining some level of centralized oversight, such as a multi-sig wallet that could override clearly incorrect resolutions.

Differentiating from Traditional Betting Platforms

While prediction markets share similarities with traditional sports betting platforms, there are key differences. Kyle points out:

"I think at a high level, no, but I think it would ultimately come down to, I guess, how their structure is doing it versus how like us or poly market is structuring their markets."

One key difference is the ability to trade in and out of positions in prediction markets, as opposed to the fixed-odds bets typically offered by traditional bookmakers. Additionally, prediction markets often cover a wider range of topics beyond sports, including politics, economics, and pop culture.

The Importance of Liquidity and Initial Odds

Setting appropriate initial odds and ensuring sufficient liquidity are crucial for the success of prediction markets. Kyle explains the challenges:

"It's trying to get as much data about a given market to figure out like where should you set the odds so that if you are providing liquidity, the market isn't immediately going against you, right?"

Hedgehog is exploring innovative approaches to this problem, including allowing users to collaboratively set initial odds through a crowdfunding-like mechanism.

Beyond the US Election: Sustaining Interest in Prediction Markets

A key challenge for prediction market platforms is maintaining user interest and trading volumes beyond major events like the US Presidential election. Kyle acknowledges this concern:

"After November 5th, what's next, right? Because right now the majority of polymarket in the news is around election stuff. It's nothing else."

To address this, Hedgehog is exploring "evergreen" markets that can sustain interest year-round. Some potential areas include:

1. Sports betting, including e-sports
2. Cryptocurrency price predictions
3. Entertainment industry outcomes (movies, music releases)
4. Regular economic indicators

The goal is to provide a diverse range of markets that can attract and retain users beyond the election cycle.

Innovative Market Types: Pooled Parlays and No-Loss Competitions

Hedgehog is introducing new market types to differentiate itself and attract users. One such innovation is the "pooled parlay" concept:

"It's effectively parlays, but with a much larger audience of people. So you're all playing, paying a flat entry fee. Um, but then you're, you know, predicting the winner of every NFL game for a given week. And if you have the most correct predictions, you either win the entire pot or split it with the other people that have the most correct predictions."

Another interesting concept is the idea of "no-loss competitions," where users can participate in prediction markets without risking their principal:

"What you can do is you could basically be playing for the interest. And I've seen some other startups that are talking about these types of things, uh, maybe not necessarily in this context, but, but for, for other applications."

These innovations aim to make prediction markets more accessible and appealing to a broader audience.

The Potential and Risks of Prediction Markets

While prediction markets offer exciting possibilities for information aggregation and decision-making, they also come with potential risks. Some critics argue that widespread adoption of prediction markets could pose threats to democratic processes or exacerbate wealth inequality.

Kyle addresses these concerns:

"I understand what he's saying where, uh, with prediction markets, um, I have seen just interesting takes and tweets where, um, it's like, okay, how much is being predicted versus how much is what we're predicting driving outcomes as well."

However, he also emphasizes the potential benefits of prediction markets in providing numerical, data-driven insights into complex issues.

Building on Solana: Advantages and Challenges

Hedgehog's decision to build on the Solana blockchain brings both advantages and challenges. The platform benefits from Solana's high speed and low transaction costs, which are crucial for a responsive trading experience.

Kyle expresses enthusiasm for the Solana ecosystem:

"We absolutely love the salon and community. Like there's just better and better tools that are coming out every day."

However, building a fully on-chain platform also presents challenges, particularly when it comes to onboarding non-crypto-native users. Hedgehog is exploring solutions like integrating with Tiplink to allow Google login options and considering ways to abstract away the complexities of blockchain interactions for new users.

The Mobile Challenge in Prediction Markets

One area where prediction markets have lagged behind traditional betting platforms is in mobile accessibility. Kyle acknowledges this gap and outlines Hedgehog's approach:

"For us, it's really just, uh, designing our platform to make sure that all aspects are mobile optimized as well. So the goal is that if you do still have a phantom wallet or soul flare wallet, um, or if you do want to use the tip link option, you could just load our website in your wallet browser or just, you know, on the browser on the phone and be able to log in and still do everything that you would do on desktop."

While regulatory restrictions make it challenging to offer native mobile apps for prediction markets, Hedgehog is focusing on creating a seamless mobile web experience and exploring options like progressive web apps.

The Future of Hedgehog and Prediction Markets

As Hedgehog continues to innovate and grow, Kyle and his team are focused on creating a diverse ecosystem of prediction markets that can sustain interest beyond major events like the US election. The introduction of new market types, improved mobile accessibility, and a focus on user-created markets are all part of Hedgehog's strategy to establish itself as a leading player in the space.

Kyle expresses optimism about the future:

"We're just excited for the, uh, the new market types that, that we're putting out. So we're hoping that, you know, we're, we're kind of targeting that shorter timeframe, uh, you know, faster type of trading, which I think a lot of people are kind of accustomed to with meme coins and even NFTs where they're, you know, either flipping or constantly trading them."

As the prediction market space continues to evolve, Hedgehog's focus on innovation, user experience, and leveraging the strengths of the Solana ecosystem positions it well to capture a significant share of this growing market.

Conclusion: The Exciting Future of Prediction Markets

Prediction markets represent a fascinating intersection of finance, information aggregation, and social dynamics. As platforms like Hedgehog continue to innovate and address the challenges inherent in this space, we can expect to see prediction markets play an increasingly important role in how we understand and interact with complex events and outcomes.

The potential applications extend far beyond political betting or sports outcomes. Prediction markets could revolutionize decision-making in business, policy, and research by providing real-time, crowdsourced probability estimates for a wide range of events and outcomes.

As Kyle DiPeppe and the Hedgehog team continue to push the boundaries of what's possible in this space, they're not just building a betting platform – they're contributing to the development of a powerful new tool for collective intelligence and decision-making. The future of prediction markets is bright, and platforms like Hedgehog are leading the way in realizing their full potential.

Facts + Figures

• Hedgehog Markets is a prediction market platform built on the Solana blockchain.
• Kyle DiPeppe, the CEO of Hedgehog, initially joined the project in an operational role before taking over leadership.
• Prediction markets have seen a surge in popularity, with platforms like Polymarket experiencing exponential growth in volume over the past three months.
• Hedgehog offers classic prediction markets with an AMM (Automated Market Maker) style, allowing free trading of yes and no shares until market closure.
• The platform is exploring new market types including pooled predictions, pooled parlays, and P2P markets.
• Hedgehog is developing its own optimistic oracle on Solana to allow third-party market resolution.
• The platform is targeting the upcoming NFL season to launch its pooled parlay feature.
• Hedgehog has integrated with Tiplink to offer Google login options, aiming to make the platform more accessible to non-crypto-native users.
• The prediction market industry faces challenges in maintaining user interest beyond major events like the US Presidential election.
• Hedgehog is exploring "evergreen" markets in areas such as sports, cryptocurrency prices, and entertainment industry outcomes.
• The platform is focusing on mobile optimization to improve accessibility, given the regulatory challenges of offering native mobile apps for prediction markets.
• Hedgehog aims to create a fully permissionless and on-chain system for market creation, participation, and resolution.

Questions Answered

What are prediction markets?

Prediction markets are platforms where users can buy and sell shares representing different outcomes of future events. The price of these shares, typically ranging from 0 to 1, represents the market's assessment of the probability of that outcome occurring. If an outcome happens, the corresponding shares pay out $1 each, while shares for other outcomes become worthless. These markets provide real-time insights into the perceived likelihood of various outcomes and have gained popularity in the crypto space due to their transparency and accessibility.

How does Hedgehog differentiate itself from other prediction market platforms?

Hedgehog differentiates itself by focusing on creating a fully permissionless and on-chain system for market creation, participation, and resolution. The platform offers classic prediction markets with an AMM style, allowing free trading of yes and no shares until market closure. Hedgehog is also exploring innovative market types such as pooled predictions, pooled parlays, and P2P markets. Additionally, the platform is developing its own optimistic oracle on Solana and is working on making prediction markets more accessible to non-crypto-native users through integrations like Tiplink for Google login options.

What challenges do prediction markets face?

Prediction markets face several challenges, including ensuring clear and unambiguous market creation, fair resolution of markets, maintaining liquidity, and sustaining user interest beyond major events like elections. There are also regulatory challenges, particularly in the United States, which can limit participation and growth. Another significant challenge is the "oracle problem" - ensuring that markets are resolved accurately and fairly based on real-world outcomes. Prediction markets also need to balance the need for decentralization with the ability to correct clearly erroneous resolutions.

How is Hedgehog addressing the challenge of maintaining user interest beyond major events like the US election?

Hedgehog is addressing this challenge by exploring "evergreen" markets that can sustain interest year-round. These include sports betting (including e-sports), cryptocurrency price predictions, entertainment industry outcomes (like movie or music releases), and regular economic indicators. The platform is also introducing new market types like pooled parlays, which allow users to make multiple predictions in a single bet, potentially increasing engagement. Additionally, Hedgehog is focusing on creating a diverse ecosystem of prediction markets and improving mobile accessibility to attract and retain users beyond major event cycles.

What are some potential risks associated with widespread adoption of prediction markets?

While prediction markets offer exciting possibilities for information aggregation and decision-making, they also come with potential risks. Some critics argue that widespread adoption of prediction markets could pose threats to democratic processes by potentially influencing outcomes rather than just predicting them. There are concerns about exacerbating wealth inequality, as those with more resources could have a disproportionate influence on market outcomes. There's also the risk of market manipulation, particularly in markets with low liquidity. However, proponents argue that the benefits of prediction markets in providing data-driven insights into complex issues outweigh these potential risks.

How is Hedgehog leveraging the Solana blockchain?

Hedgehog is built on the Solana blockchain, leveraging its high speed and low transaction costs to provide a responsive trading experience. The platform aims to create a fully on-chain system for market creation, participation, and resolution. Hedgehog is developing its own optimistic oracle on Solana to allow for third-party market resolution. The team expresses enthusiasm for the Solana ecosystem, noting the continuous improvement in tools and infrastructure. However, building a fully on-chain platform also presents challenges, particularly when it comes to onboarding non-crypto-native users, which Hedgehog is addressing through various integrations and user experience improvements.

What are "no-loss competitions" in the context of prediction markets?

"No-loss competitions" are an innovative concept in prediction markets where users can participate without risking their principal investment. In this model, users deposit funds into the platform, but instead of betting with the principal amount, they're essentially betting with the interest earned on their deposits. This approach makes prediction markets more accessible and appealing to a broader audience, as it removes the fear of losing one's initial investment. It's similar to concepts like "prize-linked savings accounts" in traditional finance, where the chance to win prizes incentivizes saving behavior without putting the principal at risk.