According to a Reddit thread on March 19, traders on Augur, a decentralized oracle and peer-to-peer protocol for prediction markets, are being scammed. The Reddit user claims that “some people” in the Augur community are exploiting a design element of the Augur protocol by purposefully creating invalid markets through ambiguous wording. This allows them to profit by gaming the system, rendering Augur “unusable.”

Augur’s co-founder, Joseph Krug, took to Twitter to explain that, admittedly there is a problem, but downplayed the extent of its effect on the network. “Some people,” as stated in the Reddit thread, is actually only one bad actor, according to Krug, and the malfunctioning element of the protocol will be fixed in the updated v2 of Augur. Krug said:

“Almost all of these purposefully confusing markets are being created by one person, not a bunch of people. The activity on those markets is also by one person / address.”

The very first response in the Reddit thread called for a “centralized system” as a possible solution to the problem, which sparked a lengthy debate on the pros and cons of centralization vs. decentralization — and both detractors and supporters weighed in.

How do prediction markets work?

Prediction markets are essentially groups of people speculating on the outcome of a future event. Traditionally, this is common in elections or sporting events, but in reality, there’s no limitation to the situations that prediction markets could be applied to. From speculating on whether certain stocks will go up or down on a specific future date to whether it will be sunny or rainy on this exact day next year, as long as the outcome will result in a clear “either/or situation,” a market can be created.

Market participants — or traders — will then buy a share in either result. If they predict the correct outcome, they will receive a payout in proportion to the value of their share; if not, they will lose their money. This is also why prediction markets are often considered betting or gambling. The key difference is that prediction markets will lean toward the wisdom of the crowd — the idea that large groups of people are more knowledgeable collectively than individual experts. The value of a bet will, in most cases, reflect the probability of an outcome materializing. As a result, market analyzers will quite often look at how a prediction market is progressing to form an opinion as to that specific market outcome.

What’s the difference with a decentralized prediction market?

Apart from trading being supposedly cheaper, the biggest difference in a decentralized prediction market, like Augur, is that outcomes are determined by the combination of an oracle and a decentralized reporter. The oracle is used to feed the information from the real world to the blockchain. Reporters then stake tokens on an outcome to verify that it matches the real-world result.

In traditional markets, the results would be determined by an impartial, yet centralized judge — which, ironically, Augur states in its white paper, would “require traders to trust the market operator to not steal funds and to resolve markets correctly.”

What is “the scam”?

Augur, which raised $5 million in its 2015 initial coin offering (ICO) and which Ethereum (ETH) co-founder Vitalik Buterin called the “Uber for knowledge” has a mechanism called a validity bond — supposedly to incentivize market creators to initiate markets based on well-defined events with objective, unambiguous outcomes. The market creator posts the validity bond and only gets their stake refunded if the outcome of the market is anything other than invalid. Validity bonds should increase if more than 1 percent of the finalized markets in the previous fee window were invalid. However, according to Krug, it is this system that is currently malfunctioning:

“Right now the bond for a market being invalid doesn’t increase as much as it should due to some bug. So the more invalid markets there are the market validity bond isn’t increasing as much as it should.”

When a market is determined to be invalid by reporters because none of the outcomes listed by the market creator is correct — or because the market wording is ambiguous — traders who settle with the market contract receive an equal amount of ETH for shares of each outcome.

Scammers purposefully create markets that they know will result in an invalid outcome, but structure the wording carefully so that it won’t be picked up by the majority of traders who enter the market. Therefore, they are guaranteed to receive a share of the entire amount settled on the contracts, as it is redistributed to all market traders — regardless of what their market stance was. They do, however, forfeit their tokens staked in the validity bond. But as the validity bond requirement is not increasing as it should, it doesn’t serve as an effective deterrent. Their portion of the funds redistributed to all traders in the case of an invalid market are potentially much higher than the funds lost as part of the validity bond.

A recent report released by Binance Research, commissioned by the Binance cryptocurrency exchange, calls it a “design flaw attack” and further considers other issues that it thinks Augur faces in its current iteration, including “low liquidity and participation rates, bare-bones usability functions, and complex voting, settlement, and forking mechanisms.”

Opinions on the Reddit debate were equally varied. Some users indicated decentralized governance is often harder because there is no legal system to hold bad actors accountable, while others argued an opposing view, stating that centralized governance is perhaps harder due to the lack of any sort of error-correction mechanism. Others made the point that this is an inherent problem with any voting system and that it is not a question of centralized vs. decentralized. Such systems will be gamed when there is enough incentive to do so, regardless of the type of network.

The big picture point of view is to see this as a learning opportunity to improve decentralized systems, according to one Reddit subscriber, RusticScentedMale:

“We’re all on here because we like decentralized systems. Denying any and all flaws by being willfully obtuse just robs us of the opportunity to improve and makes us look dumb.”

This is not the first time Augur has attracted some controversy. In December 2016, it was the center of a hacking scandal and in May 2018, it was one of four tokens removed from Japanese crypto exchange Coincheck in order to comply with Countering Financing of Terrorism and Anti-Money Laundering measures issued by Japan’s financial regulator. In July 2018, it came to light that so-called “assassination markets” were traded on the network, where users bet on the deaths of public figures, including United States President Donald Trump and the CEO of Berkshire Hathaway, Warren Buffett.

And in January 2019, a founding partner of cryptocurrency hedge fund Tetras Capital, Alex Sunnarborg, said Augur is significantly overestimating its usage. In a weekly report, Augur claimed that $2 million were involved in wagers set up by users at that point, while Sunnarborg suggested via Twitter that it’s less than $100,000: