The Decentralized Dilemma of Prediction Markets from Polymarket

Original Title: 《Polymarket and the Decentralization Dilemma of Prediction Markets｜CryptoSnap》

Original Author: dt

Original Compilation: Lisa

Recently, with the anticipated rise of the $ETH ETF, market attention has gradually returned to the EVM ecosystem. As the largest on-chain prediction market, Polymarket has attracted significant attention regarding whether the $ETH ETF will be successfully approved. As the saying goes, "the tall tree catches the wind." Despite Polymarket's substantial liquidity, its settlement method has been questioned by participants. Let’s follow Dr. DODO to explore the ins and outs of this controversial event.

Polymarket

First, let’s introduce the Polymarket protocol. Polymarket is a prediction market based on the Polygon public chain. Due to its early launch and long operational history, it is currently the largest on-chain prediction market. The platform allows traders to bet using $USDC or $ETH on the hottest and most controversial topics in the world today, ranging from national presidential elections to whether the price of $ETH will exceed $4000 the next day. Polymarket attracts market makers through a liquidity reward program, providing traders with excellent trading depth.

Polymarket has undergone two rounds of public financing. The first was a seed round that raised four million dollars; the second, on May 14, 2024, was a $45 million round led by Founder Fund. For a DApp, such a scale of financing is quite considerable.

Source: polymarket.com

UMA

When mentioning Polymarket, one cannot overlook its service provider, UMA. Polymarket uses UMA's OP oracle (Optimistic Oracle, abbreviated as OO) deployed on Polygon to ensure the fairness of prediction results.

The UMA integration in Polymarket consists of three parts: market contracts, CTF adapter contracts, and OO. Each market includes a condition generated by the CTF adapter when created, which is the question that OO needs to answer, such as "Will the price of $ETH exceed $10,000 in the third quarter of 2024?"

When the market is initialized, the CTF adapter automatically sends a request to OO. Proposers in the UMA system can respond to this request. If there is no dispute, the response is considered correct and submitted to the CTF adapter after a two-hour challenge period. If the answer is incorrect, or if other participants in UMA dispute the answer, they can debate the response as challengers.

During the first dispute, the CTF adapter will ignore the dispute and resend the same parameters to OO. If the second request is again challenged, it will be sent to UMA's DVM system (the arbitrator of OO), composed of UMA token holders who will vote to decide the outcome of the dispute.

Source: https://github.com/Polymarket/uma-ctf-adapter? tab=readme-ov-file

Controversy Over ETF Approval

Dispute Points:

Some traders believe that the $ETH ETF was not truly approved before May 31, and everything is merely speculation by UMA proposers. This is because U.S. ETFs must obtain approval for both the 19 b-4 application and the S-1 application to officially trade on exchanges, and the S-1 application has not yet been approved, meaning there is still uncertainty regarding whether the $ETH ETF can actually trade.

Timeline:

• After the U.S. Securities and Exchange Commission approved multiple Ethereum ETF's 19 b-4 applications, UMA proposers provided a result indicating the ETF's approval.

• Possibly due to the short challenge period or the concentration of UMA voting power, no voting parties raised objections during the subsequent two-hour challenge period, so the response was adopted as the final result.

• Subsequently, challengers disputed the result, requesting the adapter to resend it to OO, but the YES result was again overwhelmingly approved with up to 99% of the votes.

In response, Polymarket has not made an official statement regarding this incident.

Source: https://polymarket.com/event/ethereum-etf-approved-by-may-31

The Early and Future of Prediction Markets

The concept of prediction markets emerged long before the rise of major L1 public chains.

Augur

For example, Augur, which was first deployed in 2018, went through early versions v1 and v2 that were overly complex in architecture, ultimately optimizing into Augur Turbo, officially released in 2022. Unlike Polymarket, Augur's prediction results are determined by TheRundown data provider from ChainLink's oracle. Compared to Polymarket's UMA mechanism, the result adjudication is more centralized, which may be why it did not continue operations later, as it does not have significant advantages over centralized prediction markets, especially since centralized prediction markets are also quite willing to support cryptocurrency deposits.

Azuro

Recently, Azuro, which has been rumored to be issuing tokens, has taken a different path. Unlike traditional prediction market DApps, Azuro aims for a more foundational approach. As an emerging prediction market infrastructure provider, it attempts to facilitate other projects to quickly integrate prediction functions through a structure similar to Uniswap, rather than focusing on creating a market itself. However, it is inevitable that as long as the predictions are about real-world events, the final determination of prediction results still comes from data that is not sufficiently decentralized. According to Defillama data, Azuro's TVL (Total Value Locked) is steadily growing, and its revenue is not low among small and medium-sized DApps. It has also completed a total of $11 million in significant financing. Infrastructure providers will inevitably have the advantage of broad coverage and a large user base, and we look forward to Azuro's future development.

Source: https://azuro.org/#intro

The new generation of prediction markets represented by Polymarket is primarily built on layer one or layer two blockchains with lower GAS fees, which gives them a natural advantage over earlier projects: they no longer exclude small traders due to exorbitant GAS fees. However, prediction markets like Polymarket still have a long way to go to realize their project vision. In the current context of imperfect blockchain infrastructure, projects must make trade-offs between decentralization and efficiency. Nevertheless, the financing situation indicates that investment institutions remain optimistic about the prospects or speculative expectations of prediction markets. Technology often requires capital to drive it, so we still look forward to the future development of this sector.

Author's Perspective

We do not evaluate whether Polymarket's decision in this incident was correct, but this event illustrates that in the intersection of decentralization and centralization, decentralized products have not fully realized their vision of decentralization. When encountering off-chain events, centralized oracles are still needed for adjudication, thus presenting certain centralization risks. Currently, project parties can only strive to achieve relatively fair assessments; perhaps extending the market settlement time is a better way to handle this. This also indirectly reflects that Polymarket has a relatively small actual user base, which is why the official response to this dispute has been a cold treatment.

Before resolving the reliability of the sources of prediction results, the future of on-chain prediction markets remains full of uncertainty. Long ago, we recognized the "impossible triangle" problem of blockchain, which also exists in prediction markets. For projects to further develop, they must address the decentralization of prediction results, which may require significant changes or technological innovations at the blockchain level or even in society.