Betcoin
Betting, or prediction markets could be a central building block in the bitcoin economy. These markets can essentially assume the major functions of currency exchanges, stock markets, and insurance policies and provide invaluable prediction information. In fact, it’s hard to overestimate the power of unregulated prediction markets. If this proposal pans out, they could be implemented entirely within the bitcoin framework, and thus will inherit all of bitcoin’s distributed goodness.
The central insight here is that these prediction markets do not require a centralized referee at all, and therefore can be settled automatically by miners. The outline below borrows a lot of ideas from Intrade. It applies to a binary event outcome, so it’s not directly applicable to currency exchanges and the like, but if the basic idea is valid, it could probably be extended to more open ended bets pretty easily, as long as the value at risk can be bounded.
How it could work:
1. Someone creates a bet on a distributed betting board. The bet is made up of a unique bet id, a human-language description of the bet, a description of which circumstances will lead to a true or false outcome, and an expiration date. The expiration date can occur before the outcome happens. The bet is authenticated and entered into the block chain by a miner.
2. Once the bet is created, trade commences. A party can put in either a bid or an offer on a distributed board. Parties use the board to connect to counter-parties and transact a trade. Short selling is an integral part of the system, but is fully covered by an escrow payment.
3. If Alice and Bob agree on a trade of x shares at price y btc, they submit a secure trade agreement to the betcoin network. The price of a share can range between 0 and 10 (representing the probability that the event will occur as described). A miner authenticates the trade and adds it to the block chain. This includes a bitcoin transfer from each party to a special escrow account, which will cover any possible losses. This amount is between 0 and 10 btc per bet share. If either party does not have enough bitcoins to cover the escrow, the trade is invalid and does not enter the block chain.
4. Trade continues as usual until the expiration date. At this point, the bet is closed. The miner closes out all bets as follows: A closing price is determined by checking the last traded price in the block chain. Trades entered after the expiration date are invalid and do not enter the block chain. Bitcoins are transferred to all parties from the escrow account, awarding them the closing price of the bet, multiplied by the number of shares they’ve purchased. Parties also recieve their residual escrow funds back, minus the closing price multiplied by the number of shares they’ve sold.
5. If the event outcome has been determined in the real world, the bet price should reflect the outcome very closely and should be near 0.0 or 10.0. The bet can therefore be considered successfully closed.
6. If the event outcome has not been determined, the bet price should be very close to the concensus probability that it will happen. Trade can continue on a parallel bet that is either identical, or very similar to the original bet, and has an expiration date in the future. Speculation will ease the transition between bet series.
I haven’t seen this idea described this way before, so i’d love to get feedback on any glaring flaws I haven’t thought of. Assuming it holds water, I’m very interested about how much of it can be implemented in the current bitcoin design itself. Obviously this is a first, naive sketch and there’s plenty of room for improvement.