What are prediction markets? Wealthsimple’s newest investing feature explained

What are prediction markets?

Prediction markets allow investors to bet on the outcome of real-world events like whether Canada’s inflation rate will rise in a particular period, who will win an election, or which team will come out on top after a sporting match. The topic they’re betting on usually has a fixed number of outcomes and poses a yes-or-no question.

Investors put their support behind one of the outcomes by purchasing corresponding contracts, usually for less than $1. The more people who bet on one of the outcomes by purchasing a contract, the higher the purchase price will be. If a “yes” contract is available for purchase at 40 cents, that suggests there’s a 40% chance of the event happening.

If you guess correctly, usually these investments pay out $1 per contract. The more contracts you buy, the more you make—if you’re right.

Related reading: When investment platforms start to feel like casinos

How does it work?

Marius Zoican, the Canada Research Chair in financial technology and associate professor at the University of Calgary, used a soccer match between Canada and Switzerland as an example.

If the probability of Canada winning is 30%, an investor would buy contracts for 30 cents each. Say they buy 1,000 at that price, he said. They’d pay about $300. If they are right and Canada actually won, they’d make $1 for every contract, or $1,000 total, and make a $700 gain. If Canada lost, they’d lose their $300.

Why are prediction markets so popular?

More and more investment platforms have begun offering prediction market products. Investors tend to like them because you don’t always have to intensely study traditional markets to benefit and there’s a much broader range of things you can trade on.

“It’s not just a fixed menu that’s being set by the booking agency,” Zoican said. “If you want to create a contract that says (soccer player) Jonathan David will score for Canada or a celebrity-related contract, you can create that and people will trade on it, so you feel like you have a voice.”

What are the risks?

Critics compare prediction trading to gambling because you’re essentially placing a bet on an outcome. They say the low barrier to entry—contracts cost less than a dollar to buy, typically—makes it easy for people to get addicted and then carried away.

In reality, Zoican said the top 1% of accounts make most of the profits from prediction trading. Most investors think the prices are formed by the community and people like them, so they “stand a fair chance.” “But in reality, it’s the whales and the market makers that make money on these platforms, and that’s not immediately apparent to everybody,” he said.

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