Binary Options vs. Prediction Markets: Similarities and Differences

The massive growth and popularity of prediction markets in the past few years has now also sparked an institutional revival of binary options contracts in the US market as a direct challenge to these platforms.

Two Sides of the Same Coin

At a fundamental level, prediction markets are often described as the "financialized" evolution of binary options. This is due to the fact that there are several crucial similarities that bind them together.

For starters, both of the instruments operate on a fixed risk/reward system. This means that your downside is strictly limited to your initial stake, with no margin calls or the potential to lose more money than you put in.

Binary options and prediction markets also operate on the same yes or no, all-or-nothing settlement. The outcome is binary, and the contracts are settled at a fixed value, so you always know how much you’ll earn with a right prediction.

Another key similarity is in the fact that both instruments have a hard expiration date and time, as they are European style contracts.

Lastly, both are based around directional focus, as you are betting on an outcome, not the actual magnitude of the move.

The Key Differences

Now that we’re done with the similarities, we’ll cover the differences that you need to be aware of.

Pricing Mechanics

This is the main differentiating factor here, as binary options have fixed payouts that are set by your broker. For example, you’ll always get the percent of returns for a successful bet before you place it, with the broker acting as the counterparty.

Prediction markets, on the other hand, have prices and returns determined by the wisdom of the crowd. The range of a price is always between $0.01 and $0.99, and the price here acts as the measure of probability. For example, if you see that a prediction is trading at $0.75, this means that the market believes that this event has a 75% chance of happening.

Market Scope

Prediction markets and binary options trading platforms also operate in mostly completely different markets.

Binary options are strictly focused on trading on financial assets, like forex and crypto pairs, stocks and commodities, with most traders trading in with much shorter trade durations, sometimes going as low as just a few seconds.

Prediction markets have a totally different approach, and provide a much broader scope of choices, as you can practically trade on anything verifiable, like election results, weather events, or in the financial space, the movement of prices in the crypto market. 

Regulation and Transparency

For a while, this was also a major differentiating factor, as binary options brokers were largely based offshore, with just Nadex being regulated in the US, but in recent times there’s been a push for SEC-compliant versions of binary options.

Prediction markets, while also facing scrutiny, positioned themselves and created an image of being forecasting tools. The most popular platforms in this space are CFTC-regulated, while others use transparent blockchain ledgers to prove every trade is fully collateralized.

Side-by-Side Comparison

Final Words: Which One Should You Use?

Ultimately, the choice between binary options and prediction markets comes down to your trading horizon and your source of edge.

Choose binary options if you’re more acquainted with the technical aspects of trading and have developed strong strategies and risk management techniques to capitalize on the quick price movements of traditional assets.

Prediction markets, on the other hand, will be more suitable to you if you have a deeper understanding of the macro events than the majority of people, as you can use these platforms to capitalize on your specialized knowledge.

All in all, both of these binary-based trading types provide plenty of opportunity, with defined rewards and risk, but make sure to always approach them strategically, without risking the money you cannot afford to lose.