Crisis of trust in prediction markets: When the “truth engine” starts lying, how to build a more reliable prediction system?

Author: michaellwy

Compiled by: Shenchao TechFlow

The potential of prediction markets has been widely recognized, but some key questions remain unresolved. This article will reveal the challenges currently facing the prediction market by analyzing recent disputes, especially the difficulties in dispute resolution. This is a huge opportunity for developers: prediction markets are still in the early stages of development, and whoever can solve these core problems may lead the next wave of innovation.

introduction

Prediction markets are a tool that uses financial incentives to aggregate information . By allowing traders to bet money on their own judgment, prediction markets can drive prices closer to probabilities that reflect collective wisdom. When this mechanism works properly, prediction markets tend to produce more accurate predictions than traditional methods.

The advantages of prediction markets have been fully demonstrated in the prediction of the 2024 US presidential election. Among them, the Polymarket platform was more reliable than traditional polls and ultimately successfully predicted Trump’s victory.

As Polymarket 's credibility continues to grow, mainstream media outlets are beginning to accept it as a data source. Media that have long been skeptical of crypto projects, such as Bloomberg, not only quote its odds in reports, but even the search engine Perplexity displays its prediction data in its results, and traditional media are increasingly referring to its prediction results.

Vitalik, the founder of Ethereum, also expressed support for the prediction market. He believed : "Prediction markets and community annotations are becoming two important social cognitive technologies in the 2020s."

However, although prediction markets have shown great potential, their decentralized “truth verification” mechanisms still face many challenges. Recently, the dispute market on "Will the US Government Shut Down" on Polymarket exposed key flaws in the system design and brought important enlightenment to decentralized dispute resolution.

This article will analyze this dispute in detail, explore the design loopholes in the dispute resolution mechanism of the prediction market, and propose improvements.

How does Polymarket work?

Polymarket operates like a traditional exchange, but instead of assets, users trade probabilities. For example, in the market "Will Bitcoin reach $100,000 in 2024?" , traders can buy or sell positions through the system between 0% and 100%.

Let's say you think Bitcoin will hit $100,000 in 2024 and buy $100 worth of "YES" tokens at 47 cents. If the prediction is correct, you will receive $212 (calculated as 100/0.47), which is equivalent to the reciprocal of your purchase price. This dynamic trading mechanism allows market participants to adjust their positions at any time based on the latest information, providing real-time collective predictive insights.

Polymarket's trading mechanism is based on the Conditional Token Framework . The following is a specific case:

• Assume the total funding in the Bitcoin prediction market is $1,000:

  • Alice believes that Bitcoin will reach $100,000 and buys $200 worth of "YES" tokens for 20 cents;

  • Bob thinks it won’t be reached and buys $800 worth of “No” tokens at 80 cents;

• The system matches these two orders because they total $1,000 (i.e. 100%);

• The system receives 1000 USDC and creates 1000 "yes/no" token pairs:

  • Alice receives 1000 "Yes" tokens (20 cents each);

  • Bob receives 1,000 "no" tokens (80 cents each).

• By the end of 2024, winners can exchange each token for 1 USD:

  • If Bitcoin reaches $100,000, Alice's $200 will become $1,000 (5x gain), while Bob's tokens lose value;

  • If it is not reached, the situation is reversed, Bob makes a profit, and Alice's tokens return to zero.

On the Polymarket platform, all transactions are completed automatically through the Polygon network, and the results of the market are determined by social consensus. If market results are disputed, the UMA protocol (a system based on optimistic oracles) will step in to help verify and ultimately adjudicate the market results.

The operating mechanism of the UMA protocol is as follows:

• When market results are in dispute, any user can trigger a vote;

• UMA token holders will vote on the outcome;

• The voting weight is proportional to the number of UMA tokens held;

• The winner of the vote will be rewarded, while the loser will be punished.

The original picture comes from michaellwy , compiled by Shenchao TechFlow

For a detailed explanation of this mechanism, please refer to UMA's official video . In addition, reports from ASXN and Shoal Research also provide a more comprehensive analysis of how UMA works.

Controversy over U.S. government shutdown case

Prediction markets have shown strong capabilities in predicting event outcomes, and their success in the 2024 US election has enhanced their credibility.

However, what happens when there is a problem with the prediction market’s system? The recent market controversy surrounding whether the U.S. government will shut down has revealed some key flaws in the current design of prediction markets.

Polymarket has created a market predicting whether the U.S. government will shut down between August 30 and December 31, 2024. At first, the design of this market seems very simple. However, despite President Biden signing an appropriations bill ( HR 10545 , the American Relief Act) that successfully averted a government shutdown , and major media outlets regardless of political affiliation unanimously confirming that no federal disruption has occurred, the market is closing in on the deal Deadline still showed a 99% chance of a lockout, with the final ruling being a "yes".

The controversy over this result mainly stems from Polymarket's modification of the rules during the market operation. Specifically, the platform added a new " rule description" after a large number of transactions had occurred, introducing a deadline that did not originally exist - midnight on December 20, 2024. This change directly led to the disconnect between market results and reality.

What was supposed to be a simple binary prediction market has turned into a debate about prediction market manipulation and design flaws due to temporary adjustments to the rules.

event timeline

• December 20, 6 p.m. ( EST ): The probability of a “yes” option, predicting a government shutdown, is 20%, down from 70%. The change comes as traders widely expect the Senate to pass bill HR10545 to avert a shutdown.

Polymarket official tweet: The probability of a government shutdown has dropped to only 20%. The funding bill is about to pass.

• Later in the day: Polymarket added a banner to the markets UI stating that the market would interpret a "yes" if Biden failed to sign the bill by midnight. The probability of a "yes" option then quickly surged to 98% as traders bet that the Senate would not be able to pass the bill in time for Biden to sign.

- If President Biden doesn’t sign the funding bill by midnight, the market will read a “yes.”

• Market comment section reaction: Fierce debate broke out in the comment section. Holders of the "no" option were baffled by the sudden surge in odds, pointing to all news sources reporting that the Senate was close to passing legislation to avert a government shutdown.

• December 21, 00:38: The Senate successfully passed the funding bill.

• Morning of December 21: Biden officially signed the bill into law, and major media reports unanimously confirmed that the government shutdown had been successfully averted.

CNN reports :

Senate closes to passing funding bill, OMB won 't shut down federal government.

The Office of Management and Budget (OMB) will not shut down the federal government as the Senate moves closer to passing a funding bill, according to the White House.

"As Congress approaches passage of a related appropriations bill and the President signs it on Saturday, OMB has halted preparations for the shutdown," the White House said in a statement.

"As obligations for federal funds are generated and tracked daily, agencies will not be shut down and can continue to operate normally."

Why did the market read "yes" when a government shutdown didn't actually happen?

Even though the government didn't actually shut down, the market ultimately read "yes." To understand this result, we need to carefully analyze the original rules of the market.

Contents in the picture:

If a U.S. government shutdown occurs between August 30 and December 31, 2024 at 11:59 PM ET, the outcome for this market will be a 'Yes'. Otherwise, the result will be judged as "No".

If the acting president fails to sign a bill extending government funding by the relevant deadline, the outcome for this market will still be judged as "yes" even without an explicit declaration of a government shutdown.

No matter what form of shutdown occurs, this market will judge "yes". For example, if only some U.S. government departments receive support from the extended funding bill and other departments fail to receive funding guarantees, this market will still judge "yes".

The main basis for judgment in this market will be official information from the U.S. government, but when necessary, consensus reports from credible media may also be referred to.

source

Analysis of market rules:

1. Point 1 – This one is relatively simple, watch if a government shutdown occurs within a specified time period (note that the time period ends on December 31, 2024).

2. Point 2 – This is the heart of the dispute. "Yes" holders believe that under market rules, the President must sign the relevant bill by the applicable deadline. They believe that midnight on December 20th is the applicable deadline and that the failure to complete the signing by then should result in a "yes" market outcome (we will discuss this further later).

3. Point 3 – involves the shutdown of some government departments, but it is not relevant to the current issue, so it will not be discussed in depth here.

4. Point 4 – The primary basis for explaining market results will be official information released by the U.S. government, but may also refer to consensus reporting by credible media.

The “yes” camp’s perspective:

• Polymarket has added a banner clearly stating that midnight on December 20th is the deadline.

• The platform further supported this rule by publishing "additional background information" on December 21.

extra background

According to the rules, "If the Acting President fails to sign legislation extending government funding by the applicable deadline (12:00 midnight ET on December 20), the market will interpret this as 'even without an explicit declaration of a government shutdown' yes'."

President Biden failed to sign a bill extending funding by midnight on December 20, so the market should interpret this as a "yes."

• Since Biden failed to sign the bill before midnight, the market should automatically read a "yes" under the rules.

• They believe the rules are binding, even if a government shutdown does not actually occur.

The “No” camp’s perspective:

1. Time question:

1. The scope of the market\'s original rules is from August 2024 to December 31, 2024. The December 20 midnight deadline emphasized by the \"yes\" camp is not explicitly written into the rules, only referring to \"applicable deadlines.\"

2. Federal funding operates on a daily basis, so the actual deadline would be December 21st at 11:59pm. 

3. The fact that a banner stating a \"midnight deadline\" was still visible on December 21 defies logic because the interpretation standards have expired.

2. Actual situation:

1. The White House senior deputy press secretary [confirmed](https://edition.cnn.com/politics/live-news/trump-government-shutdown-12-20-24/index.html) : \"With confidence that the bill will be passed, OMB (Office of Management and Budget) is ready to work.\"

2. By conventional logic, missing the deadline should result in a lockout. But since a lockout didn\'t occur, that means no critical deadline was missed.

Finally, a separate Polymarket question on "Will the House and Senate pass an appropriations bill before midnight?" correctly ruled a "no." The key point here is that missing a procedural deadline does not equate to a government shutdown, which conflates process with outcome. This is why there are two separate pages, because the spirit of the market is different.

The core tension here is not just a matter of interpretation, but about whether prediction markets should prioritize the interpretation of technical rules over the real-world outcomes they are supposed to predict. When markets rule “yes” on a government shutdown that objectively never happened, something is wrong with the truth-seeking machinery.

Similar controversies are not uncommon

One might think that this was an isolated incident due to poorly written rules. But in fact, similar controversies are not uncommon. A watchdog website called Polymarketfraud (pardon the provocative name) has documented numerous cases where market rulings contradict reality.

The Venezuelan presidential election winner market is particularly interesting. Venezuela's current president is Nicolas Maduro, but the market has ruled that opposition candidate Edmundo Gonzalez won the recent election.

Frank Muci explores this in more depth in this article . Here's a brief summary.

1. The market rules clearly state: “The main basis for resolving disputes is Venezuela’s official information, but credible media reports can also be used as a reference if there is a consensus.”

2. Official election results show Maduro won:

3. First announcement: 51.20000% vs. 42.20000%

• Second announcement: 51.9500% vs. 43.1800% (This result is accurate to multiple decimal places, especially with multiple zeros, which makes people doubt its authenticity and may involve data fraud).

1. However, according to polling station statistics, the opposition's vote share showed that they were ahead by more than 20%.

2. UMA token holders (who have the final say in resolving disputes) were heavily lobbied to ignore official sources of information in Venezuela and instead rely on consensus reports of electoral fraud from credible media outlets.

3. Ultimately, UMA holders voted to overturn the main basis of settlement stated in Polymarket's rules and rule in favor of González - even though Maduro remained in power.

The inconsistency in this approach to decision-making exposes the problem. In the case of the U.S. government shutdown, UMA voters strictly adhered to a technical rule (i.e., a late-added clause regarding a midnight deadline), ignoring the fact that the media consistently reported that a government shutdown was not occurring . In the case of the Venezuelan election, however, they took the exact opposite approach, overruling key sources of information in favor of consensus media reports of electoral fraud.

Fraudulent Markets

(source )

This list is currently being expanded and work is underway to research other markets. It is reasonable to assume that in all the markets mentioned, countless (new) users lost significant amounts of money, while some of the top users mentioned above made significant profits on their costs. Although there is currently no conclusive evidence, there is reason to suspect that these accounts may have coordinated behavior and/or possessed inside information in the UMA voting process and/or Polymarket clarification.

In addition, it can be further noted that the rules regarding “Will there be a US Government shutdown?” are deliberately misleading and do not clearly state which deadlines are valid for market resolution. Yet all indications are that this market should resolve to YES, should a government shutdown do occur before 2025, for example.

Polymarket should consider refunding users affected by these fraudulent marketplaces and/or adopting a 50/50 solution where applicable. Without action, this controversial market trend will continue, resulting in profits for a few large users and losses for large numbers of new users. This may be a matter that the CFTC and/or the FBI should pay attention to and investigate as soon as possible.

Another case involves the Israeli-Hezbollah ceasefire market . Despite credible reports that military action is continuing, markets are still pricing the outcome as "yes." A YouTube video titled " Game Prediction Markets: Lessons Worth $40 Million " explains the incident in detail.

Additionally, Lou Kerner proposed an interesting theory in his article about potential issues with the U.S. election market. Although he calls it a "conspiracy theory," his analysis points out that Polymarket's presidential election market may be structurally biased toward Trump.

The scenario he envisions is this: If Trump loses, he might refuse to admit defeat, as he did in 2020, claiming voter fraud and disputing the election results. So even if Kamala Harris actually wins the election, markets may not price the outcome in her favor.

This situation creates a "heads I win, tails I don't lose" situation for Trump's supporters. If Trump wins, bettors will profit directly; if he loses but disputes the result, market resolution may be delayed or changed due to the votes of UMA token holders.

Problems that arise

The first is the issue of rule manipulation. When the platform can add instructions at will, the role of the oracle becomes useless. In the case of the government shutdown, the posting of the new banner caused market odds to quickly surge to "yes" and change the original effective deadline from December 31 to December 20, 2024.

This also raises other questions about resolution standards. When rules conflict, which rule should prevail? Although the main resolution criteria clearly stated news sources and credible reports, and set a deadline of December 31, the market ultimately relied on a clarification of midnight on December 20 that was later added to make the resolution. This inconsistency in rule priorities severely damages the credibility of the market.

Another structural challenge lies in the relationship between UMA holders and the Polymarket resolution system. Since UMA token holders can participate in both transactions and voting, a strong interest-binding relationship is formed between large traders and oracle voters.

Although Polymarket and UMA are supposed to act as independent systems to check and balance each other, in fact UMA is Polymarket's only oracle provider. This reminds me of a scene in the movie "The Big Short" where the ratings agency employees admit that they must give a AAA rating or the banks will switch to a competitor. When the success of a system depends on pleasing powerful actors, independence is out of the question.

Dispute Resolution: The Achilles’ Heel of Prediction Markets

The core value of prediction markets lies in its ability to accurately determine facts. No matter how perfect the user interface (UI) is, no matter how complex the trading system is, and no matter how abundant the liquidity is, it will all be meaningless if it cannot reliably determine who has won the bet. Polymarket currently relies on UMA's oracle system to resolve disputes, but the operating mechanism of this system may have potential loopholes.

Overview of the basic mechanism of UMA :

• When market results are disputed, any user can trigger the voting process.

• UMA token holders vote on the results according to the rules.

• The size of the voting rights depends on the number of UMA tokens held by the user.

• Voting winners are rewarded, while losers are punished.

In the Dirt Roads blog, Luca Prosperi proposed a concept called " Corruption Value Multiple (CVM)" for Polymarket's oracle problem to measure the potential risks of the market. Here is his analysis:

• Currently, the total value of open bets on Polymarket is approximately $300 million, while UMA's total market capitalization is only $220 million.

• Controlling half of UMA's tokens requires approximately $110 million.

• This means that for every $1 spent controlling UMA, $1.36 worth of bets could be affected.

However, the actual risk may be higher for reasons including:

• The actual voting rate of UMA tokens is usually only 20%, which is far less than 100%.

• Market rules are often vague, leaving gray areas for dispute adjudication.

• Voters may be influenced by public opinion or interested parties.

• Influencing market outcomes may require far less than the theoretical $110 million.

This means that if traders believe they can influence the outcome by manipulating the oracle’s rulings, they may artificially drive market prices to levels far beyond their true probability.

These issues reflect the complexity in the design of prediction markets. Although there is currently no “one-size-fits-all solution”, the improvement of dispute resolution mechanisms is undoubtedly one of the most important challenges facing prediction markets. If market ruling results are inconsistent, users' trust in the system will gradually erode, ultimately causing the market to deviate from its original goals.

Direction for improvement: How to optimize the dispute resolution

mechanism?

Fixed market rules, prohibiting subsequent modification. Once a market goes live, its rules should be locked in and cannot be changed. Market terms should not allow for any form of "additional explanation" or "post-clarification" after creation. The original rules should be used as the sole reference. When a dispute occurs, the oracle shall rule strictly in accordance with these basic rules without being interfered by content added by the platform.

Establish rule priorities and on-chain records. Market rules require clear prioritization. For example, when there is a conflict between rules, which rules have higher authority? Primary interpretive standards (such as credible media coverage) should clearly take precedence over secondary mechanisms. This level of rules should be recorded through the blockchain when the market is created, forming an untamperable chain of evidence to ensure the transparency and authority of the rules.

Reputation-based verification mechanism. In addition to existing token voting, the market could introduce a reputation-based council system. The system consists of respected industry experts who participate in adjudicating market outcomes, backed by their professional reputation. This mechanism not only introduces greater professionalism but also increases social responsibility in the verification process.

Intersubjective bifurcation mechanism. Inter-subject forking is a mechanism borrowed from Eigenlayer innovation, specifically designed to handle obvious errors that human consensus can identify. When a major dispute arises in the market, the community can split the token used for adjudication (whether it is an oracle token or a protocol token) into two versions, each supporting a different interpretation of the outcome. The market’s selection mechanism will then determine which version of the token retains value. The party that supports the wrong interpretation will be financially and naturally punished by the decline in the value of its token, effectively curbing manipulation.

AI agents serve as independent arbiters. In order to avoid possible manipulation by token holders due to financial motivations, we can develop a dedicated artificial intelligence agent (AI Agent) whose sole purpose is to adjudicate market outcomes. Unlike humans who may vote based on their own position, AI agents can be designed to be completely neutral and focus on analyzing the evidence impartially, thereby providing more accurate market rulings. This method can significantly improve the market's credibility and decision-making efficiency, while reducing the possibility of human interference.

in conclusion

First of all, it needs to be stated that this article is not specifically intended to criticize Polymarket. However, as the largest (and frankly, the only actually influential) player in the cryptocurrency prediction market right now, it’s the best case study for understanding the challenges facing the industry as a whole.

Why are these questions so important? If we think of a prediction market simply as a speculative platform where traders bet on outcomes, its flaws have relatively limited impact. Sure, some people may lose money on this, but at the end of the day, it's just another place to speculate.

However, prediction markets are being given a higher status, and they are regarded as "truth engines" - objective tools that can filter out noise and bias and reveal the true probability of future events.

That’s why government shutdown cases are causing concern. When the market confidently predicted and validated a government shutdown that never actually happened, it revealed how these so-called “truth engines” could create a false reality that was inconsistent with the facts. The problem is not just the financial losses of some traders, but the greater danger is that these "objective verification systems" we are building may be used by those with capital and motivation to manipulate public perception.

As prediction markets grow in influence, their structural weaknesses become a problem for everyone to face. If we fail to address these fundamental vulnerabilities, we risk turning prediction markets into powerful tools for distorting the truth rather than discovering it.