A Deeper Dive on Prediction Markets
We posted a couple of weeks ago about problems with prediction markets. Now, via the Don Moynihan’s Substack, Can We Still Govern, Ashley Splawinski goes deeper with a post entitled “The (Poly)Market Nobody Knows How to Govern.”
First, some money quotes:
When prediction markets are cited as evidence of what the public believes, and the odds are being moved by actors with non-public information, the “future of news” starts to look less like a forecasting tool and more like an information asymmetry problem with a financial instrument attached.
In a standard commodity futures market, the underlying asset, such as corn, oil, an interest rate, exists independently of the contract written against it. Political prediction markets are different. When enough money moves on an election outcome, the market doesn’t just reflect political reality, it potentially shapes and reshapes it.
Researchers at Columbia University found that roughly 25% of all trading on Polymarket over the past three years consisted of “wash trading.” This is an illegal form of market manipulation where users rapidly buy and sell the same contracts to artificially inflate activity. The figure varied by category: 17% of election-related trading, 45% of sports-related trading.
Here are some takeaways, but I of course encourage readers to read the full post and more.
- Prediction markets are supposedly regulated by the Commodity Futures Trading Commission (CFTC), but the CFTC currently has only one Commissioner.
- Prediction markets go back to 1988, when three Iowa professor launched the Iowa Electronic Markets as a mechanism to test whether markets could solve marketing problems. The CFTC issued a no-action letter so long as wagers were capped at $500 and the pools were limited to 2000 people.
- Kalshi and Polymarket build on this precedent, but their goal is not to develop a science of prediction but to generate profits.
- In 2024, a District Court ruled that Kalshi was not engaged in illegal gaming when it hosted predictions markets about congressional elections, stymying the CFTC’s efforts to regulate markets.
- By March 31st, users bet over $31 million on a Polymarket prediction market on whether the U.S. would send ground troops into Iran.
- Donald Trump, Jr. is on the board of Polymarket and is a “strategic advisor” for Kalshi.
- Prediction markets can be highly reliable if they reflect genuine belief, but evidence keeps mounting that they are skewed due to “privileged access,” which sounds like a euphemism for insider trading, except that these markets are not subject to securities regulation.
- Two proposed congressional acts would prohibit prediction markets on sports and would ban politicians from engaging in political prediction markets, but Kalshi and Polymarket have countered with a pledge to self-regulate.
- The CFTC and states are competing over jurisdiction, with the CFTC trying to regulate prediction markets as swaps while the states try to regulate them as gambling.
- The CFTC has initiated a regulatory process, which might take years to finalize. In the meantime, the CFTC’s more consequential action has been to intervene in state proceedings to prevent any state regulation of the prediction markets.
Ashley Splawinski thus concludes her contribution to the Can We Still Govern Substack by observing, “The institution claiming sole authority to govern [prediction markets] has, so far, spent most of its energy making sure no one else can.”