An Analysis of the Operating Mechanism of the Decentralized Prediction Market Augur (REP)

Source: cryptopedia

Compiled by: Hu Tao, Chain Catcher

How does Augur's prediction market work?

Augur is a decentralized prediction market built on Ethereum that allows users to bet digital assets on the outcomes of real-world events. Unlike traditional betting platforms, Augur's prediction market facilitates betting on outcomes without the need for a central authority. Instead, Augur uses smart contracts that execute under set conditions—specifically, when the outcome of an event is confirmed. A notable feature of the Augur betting platform is that its markets are global, anonymous, and virtually unrestricted in terms of limitations and participation.

Similar to traditional prediction markets, Augur users place bets on the outcomes of future events with the goal of predicting the correct outcome and earning rewards. The less likely an event is to occur, the higher the reward; the more likely an event is to occur, the lower the reward. The platform was one of the first to raise funds through an Initial Coin Offering (ICO) in 2015. When the project launched in 2018, over 800 outcome bets worth $1.53 million were placed within the first month, and the platform has significantly grown since then.

In addition to the entertainment and speculative elements of betting, Augur's prediction market incentivizes crowdsourced truth through decentralization. While cryptocurrencies like ETH and DAI are widely used as trading currencies on the platform, Augur's native REP token serves multiple functions. REP is used to create prediction markets, participate in the Augur betting outcome reporting process, dispute the results of outcomes, and act as a reward currency.

Three Types of Augur Prediction Markets

Augur's betting markets follow a four-step process that determines the flow of platform value: creation, trading, reporting, and settlement. Users can create a prediction market on the Augur crypto platform as long as the market represents a real-world event and can be confirmed with a clear outcome at the end of a specified period. Creators can establish three different types of markets: Yes/No (binary), multiple-choice, and scalar:

Yes/No (binary): These markets are the most straightforward, as only "yes" or "no" outcomes are possible. Example: Will the price of Bitcoin be above $50,000 on August 31, 2021?

Multiple-choice: Multiple-choice markets have more than one potential outcome. Example: Who do you think will win the 2022 Super Bowl?

Scalar: These markets use a lower and upper limit to construct bets. Therefore, traders need to choose their execution price within that range—that is, the price at which they intend to go long or short. Example: Will the price of ETH be between $1,000 and $2,000 in 30 days?

Focus of Augur Betting Markets

Once a prediction market is created, trading can begin immediately. Traders wishing to participate in a specific market can buy shares of potential outcomes. The payout of rewards varies by market type: Yes/No, multiple-choice, or scalar. We can further break down this structure for each market type.

YES/NO prediction markets: If the market outcome is YES, then YES buyers and NO sellers receive one DAI per share in the market. If the market outcome is NO or Invalid, they receive nothing. If the market outcome is NO, then NO buyers and YES sellers receive one DAI per share, but if the outcome is YES or Invalid, they receive nothing.

Multiple-choice prediction markets: Buying long shares in a multiple-choice market reflects a belief that the chosen outcome is possible. Conversely, buying short shares reflects a belief that the chosen outcome is impossible. Therefore, if the chosen outcome occurs, long share traders receive 1 DAI; otherwise, they receive nothing. If the outcome does not occur, short share traders receive 1 DAI, and if the outcome occurs, they receive zero.

Scalar prediction markets: These markets use predetermined boundaries to predict where the outcome will fall. Therefore, when the market settles, three scenarios may occur:

If the market outcome is below the lower limit, sellers receive one DAI per share, and buyers receive zero.

However, if the outcome is above the upper limit, buyers receive one DAI, while sellers receive zero.

If the outcome falls within that range, buyers of outcomes below the settlement price and sellers of outcomes above the settlement price will receive the difference between the opening price. Similarly, if the outcome settles within that range, buyers of outcomes above the upper limit and sellers of outcomes below the lower limit will pay the difference between the opening price.

Augur Crypto Platform Reporting and Settlement

Augur users must choose a reporting source when creating a market. These sources verify event outcomes and trigger the issuance of reward payments. Oracles bring real-world information to the blockchain through a decentralized oracle system and require market reporters to reach a consensus on the outcome. Reporters stake REP tokens so they can report event outcomes for different markets. However, if they are not part of the consensus, reporters may lose their stake.

When users create a market, they must also select designated reporters and post a bond in the form of REP tokens. Once the market event occurs, the designated reporter has three days to report the outcome. If the designated reporter fails to report the outcome, the market creator loses their bond, and the event enters the open reporting phase.

During the open reporting phase, anyone can report the event outcome, not just the designated reporters. The bond will be awarded to the first user to report the outcome. Once the decentralized Augur oracle determines the event outcome and the reporting process is complete, traders can close their positions.

Improvements in Augur v2

While Augur v1 was the first integration of prediction markets and blockchain, the Ethereum ecosystem has been rapidly evolving, and Augur has been growing as well. The 2020 version of Augur v2 is a response to the evolution of decentralized protocols since the launch of v1 in 2018. The Augur v2 update includes improvements to dispute management and resolution, introduces more secure oracles, and replaces the REP (REPv1) token with REPv2. The following integrations highlight the most significant changes in the Augur crypto network:

Augur v2 and 0x: The use of 0x Mesh supports off-chain order books, allowing for free "maker" or buy orders. Thus, Ethereum transaction fees are paid by the order "taker" or seller. The 0x protocol supports greater liquidity on the Augur crypto platform by encouraging participation in prediction markets.

Augur v2 and Uniswap version: This Uniswap version upgrade now broadcasts price signals for exchanges to drive the V2 network. Previously, the market capitalization of REP tokens was provided by a semi-centralized oracle.

Augur v2 and Portis, Fortmatic, or Torus: Augur v2 aims to provide a more user-friendly experience that can broaden the platform's appeal. This Web2 approach simplifies the authentication process and supports wallets from Portis, Formic, or Torus.

Augur v2 and DAI: On the Augur v1 network, users bet with ETH, which is subject to fluctuations in the crypto market. In response, Augur v2 uses the DAI stablecoin for betting through MakerDAO, providing a more stable user experience.

While most users of prediction tokens like Augur primarily care about earning rewards by correctly predicting real-world events, the platform inherently possesses a mechanism for crowdsourcing truth. While the information age and the internet have democratized access to information, the authenticity of that information often remains an issue.

By incentivizing users to participate in crowdsourced opinions and then creating mechanisms for information verification, prediction markets can play a significant role in maintaining the honesty of information—even as the amount of available information continues to increase. As a pioneer on Ethereum, Augur continues to develop its product and strives to remain at the forefront of prediction markets and the broader decentralized ecosystem.