Opinion

Prediction markets: Cultural phenomenon or institutional asset class?

Phillip Silitschanu, senior vice president of digital assets at Arcesium, argues that prediction markets could become a major institutional hedging tool, but only if firms modernise their infrastructure to integrate blockchain-based assets.
By Phillip Silitschanu

Currently, World Cup trading volume in prediction markets has soared to $5.4 billion, eclipsing all previous records. No doubt, Kalshi and Polymarket are part of a sizzling cultural phenomenon. But Kalshi insists that its endgame is institutional investing, intent on installing “the essential infrastructure for being the next-generation derivatives exchange.”

As with crypto and stablecoins, speculation is the dangling carrot of institutionalisation. With the CFTC and SEC eager advocates, prediction markets will emerge as a way for firms to more precisely hedge and mitigate risk from otherwise illiquid events. But to do so, institutional investors will need to be able to standardise digital asset positions alongside traditional assets and provide real-time risk exposures by integrating blockchain capabilities into operations at scale.

A perfect instrument for multi-dimensional hedging

Blockchain-native prediction markets offer structural benefits that improve the efficiency and safety of hedging as compared to traditional derivatives. A manager has more dials to turn and levers to pull to hedge against the effects of market volatility. With a prediction market contract, a manager concerned about war or a weather catastrophe can hedge a macro fund or energy portfolio’s exposures by betting on the probability of the actual event outcome, without taking on unrelated exposures baked into commodity futures or options. Managers gain the ability to isolate a specific risk factor in real time with greater precision.

Blockchain: An immutable hedging technology

The blockchain’s immutable, distributed ledger has an advantage because it is decentralised, transparent, and uses more automated infrastructure, which eliminates much of the counterparty risk. In TradFi, futures contracts and options are more time-consuming to create, whereas blockchain’s self-executing smart contracts can be automated through AI, practically able to create their necessary terms on the fly.

Once a trade settles, immutability means there is no cancel-rebook process as found in traditional derivatives. Further, settlements are instant, and failed trades become virtually obsolete. The middle- and back-offices gain newfound certainty since both parties’ information is in the same format and in complete synchronisation on chain. Finally, the markets ensure tamper-proof outcomes based on verifiable data.

Prediction markets construction is underway

Institutions are keen to trim their counterparty involvement, smooth out reconciliation workflows, and reduce associated costs.

However, prediction market firms must develop institutional trading infrastructure for event contracts by partnering with traditional players, liquidity providers, and prime brokers. Investors will need to handle and consolidate surging volumes of new data to manage risk and liquidity in real time. Integrating blockchain capabilities into fragmented data, operations, and risk systems at scale will take time and forethought, especially given the speed involved.

Prediction markets’ unique complexities

Prediction markets transform hedging from a narrow financial exercise into a sophisticated analysis, uncovering the truth about risk exposures and enabling more intelligent operational decisions. But that involves millions of data points. Risk systems often require custom logic to model event-specific exposures.

Prediction markets also come with regulatory and legal contract classification issues. Plus, a new category of event-driven instruments introduces challenges around valuation, risk aggregation, data integration, and reporting. These complexities will stall progress if institutions use parallel operational systems and fragmented data across their tech stacks.

Data roadblocks hamper a total portfolio view

The integration of prediction market strategies makes it more challenging to get a clean, instant total house view of the portfolio. It is prohibitively complicated to manage different books of record for public and alternative instruments, including digital assets that underpin prediction markets.

Spreadsheets and vibe coding will only get managers so far as the on-chain segments expand. To have any hope of scaling prediction market hedging, investors must have a unified operating model across the portfolio. When it comes to blockchain instruments, spot, ETFs, perpetuals, futures, and crypto options should all run through the same accounting, reconciliation, treasury, and reporting framework to ensure accurate NAV, P&L, and operational oversight.

Institutions, get ready for a TradFi-DeFi hybrid world

Prediction markets are one of many financial innovations coming out of blockchain, which will result in virtually every investment asset becoming tokenised in the next few years. Until then, managers and investors looking to bring prediction markets into their portfolio, whether to bet or hedge, will need to deploy upgrades, new interfaces to ensure systems can handle blockchain-based transactions, and data infrastructure that can ingest data, no matter if it comes from a traditional world or a crypto-native world.

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