Prediction Markets Are the Hot New Thing, but Will They Be a Good Long-Term Investment?

Over the past 90 days, only 12 of the top 100 cryptocurrencies are in the green. Many -- including Bitcoin (CRYPTO: BTC) -- are down 25% or more during that time period. Against that backdrop, it might seem impossible that crypto investors are making money these days.

But there's one way to make money in a down market that is relatively new: investing in prediction market contracts. Until recently, the top two prediction market platforms were Kalshi and Polymarket. But Robinhood Markets (NASDAQ: HOOD) and Coinbase Global (NASDAQ: COIN) are getting into the act now, and crypto prediction markets are really heating up.

So are they worth investing in or not?

How to invest in prediction markets

For crypto investors, prediction market contracts can be divided into two basic types: those that attempt to predict the future price of a specific cryptocurrency, and those that attempt to predict the outcome of a specific crypto industry event.

Image source: Getty Images.

For example, investors can attempt to predict the future price of Bitcoin. On the Robinhood app, you click on the "Investing" tab, click on the "Prediction Markets" link, and then hit the "Crypto" tab. There, you'd see a wide range of potential Bitcoin contracts you could trade.

If you're a short-term investor, you could attempt to predict the price of Bitcoin over the next month. If you're a long-term investor, you could attempt to predict the price of Bitcoin over the next year.

The rules are simple: If your cryptocurrency hits a certain price target (or if a certain crypto industry event occurs), you make money. If the event does not occur, you lose money.

During the time period of the contract, you're free to trade the contract to someone else. So it's not quite the zero-sum game it might appear to be. There's still a way to cash out and make a minimal profit before the expiration of the contract.

Is this just another speculative mania?

Admittedly, this can seem like a form of legalized gambling. It almost seems like you are betting on the outcome of a certain event -- the same way you might bet on whether a certain team wins a football game, or whether a certain player scores a touchdown during that game.

However, major prediction market platforms are regulated by the Commodity Futures Trading Commission (CFTC). And all prices are set by investors, not by "the house." So a more accurate analogy for prediction market contracts might be the trading of futures contracts.

In other words, you're essentially trading financial derivatives when you invest in prediction market contracts. Some people make money trading futures contracts, and some trade options contracts. So it only makes sense that some people will make money trading prediction market contracts.

But be forewarned: Prediction markets are still so new that it's not entirely clear whether this will be a long-term trend, or just a short-term speculative mania. That being said, prediction markets provide a potential way to make money, regardless of which direction the crypto market is headed. At a time when most cryptocurrencies are in the red for the year, that's welcome news.

Dominic Basulto has positions in Bitcoin. The Motley Fool has positions in and recommends Bitcoin. The Motley Fool recommends Coinbase Global. The Motley Fool has a disclosure policy.