Prediction market: An extended form of binary options

After following the prediction market, I increasingly find that it is quite similar to binary options in many ways. Although not exactly the same, from a certain perspective, the prediction market can be said to be an extension of binary options.

Prediction markets, such as Polymarket, kalshi, and Opinion, use yes/no binary contracts. The price reflects the market consensus on the probability of an event occurring, such as predicting “Will BTC exceed $100,000 in January 2025?” The price fluctuates between 0 and 1, with the real-time price reflecting the market's consensus on the probability of the event occurring. If the price is 0.7, it means that people in the market believe there is a 70% chance it will happen. At expiration, the settlement is based on the result: if it happens, it is worth 1; if it does not happen, it is worth 0. Doesn't this seem very similar to binary options?

The core of binary options is also based on “yes/no” or “happen/not happen” predictions. For example, a binary options contract might stipulate that if the price of Tesla stock is above a certain level on the expiration date, a fixed amount (e.g., $1) will be paid; otherwise, $0 will be paid. This essentially prices the probability of an event. In other words, it is essentially a form of predicting future events. Some financial players, in practice, use binary options as a tool for predicting financial events.

In simple terms, both estimate the probability of future events occurring through market prices (a contract price of 0.6 means the market believes the probability of the event occurring is 60%), both aggregate the wisdom of many participants in the market, and allow participants to speculate (bet on the outcome of events) or act as a risk hedge. Binary options are like a financialized version of prediction markets.

There are also some differences.

The prediction market has a wider scope, allowing any verifiable event to be included, such as weather/box office receipts and other non-financial events, with more flexible event durations. Binary options primarily focus on price predictions of financial assets, such as foreign exchange/stocks/commodities, usually with short expiration times (minutes/days).

In terms of market liquidity and depth, binary options are more speculative and more like gambling, with liquidity depending on the broker; prediction markets emphasize the accuracy of event predictions, and even predictions outperform polls (after all, participating with real money makes a difference), and the incentive mechanism encourages input of real information.

Finally, in terms of regulation and legality, binary options are considered high-risk financial products in some countries (such as certain regions of the European Union) and are strictly regulated, with some places even prohibiting participation (due to their gambling nature); in the United States, trading can only occur on exchanges regulated by the CFTC (Commodity Futures Trading Commission). Currently, the crypto prediction market is still in its early stages, and regulation is not yet clear, and it may gradually be brought under regulation due to “manipulation events” or others in the future.

These differences may lead the prediction markets to take different paths, and there will also be differences in future regulations.