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Futarchy Capital Efficiency

Example of the futarchy capital efficiency problem. Imagine that a blockchain community is considering doing a hard fork to change the rules of their blockchain. But currently, almost no one supports this hard fork, so the odds that it will occur are practically zero.

Imagine that you have solid evidence that the hard fork would be good, and you want to create a futarchy market to profit from sharing this information.

The futarchy market would involve:

  • a binary market betting on whether we do the hard update. This creates 2 shares: update-yes, and update-no
  • a scalar market priced in update-yes, to predict the value of tokens conditional on us having done the hard update.
  • a scalar market priced in update-no, to predict the value of tokens conditional on us not having done the hard update.

By comparing the predicted token price in the 2 scalar markets, we can know what impact this hard update will have on the token price.

But, if the odds that the hard update will occur are practically zero, it is very expensive for someone to make meaninful bets to influence the price of the update-yes market. To buy $1 of update-yes tokens, and be hedged against the possibility that the hard update will not occur, you could need to buy >$100 of update-no tokens. So it is just too expensive for anyone to bet in the update-no market. So the price of the update-no market will not be a good signal of whether the hard update is good or bad.

Solution

If the probability of an event occurring is practically zero, even with solid futarchy evidence showing that it is in our shared interest, then there is no reason to use futarchy.

If a community is willing to change it's decision based on futarchy evidence, then you as an investor who thinks you have solid evidence that the hard fork will be good for the price of bitcoin, you don't want to hedge yourself at the current 0.01 price that the fork will occur.

You want to buy lots of shares saying that the fork will occur, and significantly increase the price of the yes-fork tokens. Possibly hedging yourself at 0.5 odds or greater. Because you have an expectation that the change in price of (hard fork increases the price of bitcoin) will positively impact the price of (we do the hard fork).

Futarchy gets more powerful in communities that believe in it.