Prediction Markets with Alex Johnson

I am obsessed with prediction markets! 

But maybe not for the same reasons as you. 

I am obsessed with how quickly they have grown, how they seem to be on track to disrupt the gambling industry entirely in no short order, and how they seem to have evaded appropriate regulatory oversight.

An alarming stat: we know that when a state legalizes online sports betting, bankruptcy rates increase by 25-30% over the next 3 to 4 years, and so to me, the fact we’ve found a way to avoid state gambling regulation is… worrying to say the least.

Are we creating a whole generation of gamblers? Have we found a way to avoid gambling regulation? Is it simply another tool through which the rich get richer and the poor get poorer?

To understand more about prediction markets I begged Alex Johnson, founder of Fintech Takes, to chat to me. He’s the fountain of much knowledge, and like me, is pretty obsessed with what’s happening here. This episode is a cracker, and we covered so much, including:

→ What prediction markets are and how they work

→ The regulatory landscape they exist within, and that which they’ve managed to avoid

→ Where their volumes come from - what kind of predictions are being made?

→ Some pretty suspect behaviours linked to politics and predictions on these markets

→ How Robinhood and others are starting to present prediction markets as an investment opportunity

Transcript

SPEAKER_00 0:00

Before FTX blew up, I got a fortune from FTX that was sponsored by FTX and my fortune cookie. Um and that was always just like a signal for me that like something is wrong with this company or this market if money is like leaking into this place. Prediction markets are the new version of this.

SPEAKER_01 0:20

Hello and welcome to In Control, where we learn about the finance of everything. I'm Tash, your host, and I'm also the CEO and founder of Cable, which supports the show. If you enjoy this podcast, please subscribe on Apple Podcasts or Spotify and share it with your friends and colleagues. A recent obsession of mine, and seemingly the entire US, is a prediction market. But unlike most of the US, my obsession isn't about trying to make a quick buck using them. I am obsessed with how quickly they've grown, how they seem to be on track to disrupt the gambling industry entirely, and how they seem to have evaded appropriate regulatory oversight. An alarming stat is that we know that when a state legalizes online sports betting, bankruptcy rates increase about 25 to 30% over the next three to four years. And so to me, this is a very worrying trend. These are all top of my mind because right now, financial nihilism feels very real. For most people I know, and for most younger people, the path to being able to buy a house feels like a gamble. The path to a solid financial future feels simply impossible. And so, understandably, people are trying to get rich quick. I think that has always been a big part of the crypto boom. And I can't shake the feeling that it is behind the astronomical rise of prediction markets as well. So are we creating a whole generation of gamblers? Have we simply found a way to avoid gambling regulation? Is it simply another tool through which the rich get richer and the poor get poorer? As always, I don't know enough about this space to say much more than I've already said. And so I'm speaking to Alex Johnson, founder of FinTech Takes, and another prediction market obsessive. Alex, thank you for chatting with me today. I am so excited to have this conversation. And I want to start by understanding what prediction markets actually are.

SPEAKER_00 2:11

Well, thank you for having me. Uh as you said, I share your obsession with this particular topic. Um, it is both important to me and the work that I do covering the financial services space, as you outlined, and the impact on consumers and their balance sheets, but it also is just purely, from an academic perspective, really fascinating. So I'm happy to talk about what these things are and kind of how they've grown and changed over time. So maybe to start with a very simple definition and explanation. Um, prediction markets are platforms for peer-to-peer betting on real-world events. I think that's probably the easiest way to describe them. So if you were to go on to one of the prediction markets like Calchi or Polymarket, those are the two biggest, uh, what you would see is a range of different real-world events that have not yet settled, which is to say we don't know the outcome of the event yet. And this could be everything from elections to sporting events to uh who's going to win best pitcher at the Oscars. All of these things are available as event contracts on prediction markets. And what you will see is a price that varies between uh zero dollars and one dollar. And the price for yes, meaning yes, I think this event will happen, uh, reflects the odds of that contract at any one time, right? So if you go and you look at an event on Calci and it says um that uh yes is uh selling, trading currently at 63 cents, you can think of that as uh the market believes that this event has a 63% likelihood of happening. And obviously, uh because these events are listed sometimes well in advance of when they're expected to settle, the contract value will change, right? So as the odds differ, uh the price will go down from 63 cents to 50 cents, and then it'll shoot back up to 80 cents. Uh, just to give you one example, I was browsing for a second on Calci before we hopped on to record. Uh, one thing you can bet on is whether the US government will confirm that uh alien life exists uh before January 1st, 2027. Uh, yes, is currently trading at 23 cents. But again, uh if something were to happen, if former President Barack Obama were to give an interview where he sort of hinted at the existence of alien life uh as known by the US government, the value of that contract might change because more people might think that it's likely to happen. Um fundamentally, that's what these things are. They've been around for a long time. I can give the history on it, but hopefully that gives a little bit of a at least definitional sense of how these things work.

SPEAKER_01 4:58

That's awesome. That really grounds us. Let's take let's continue with that alien existence argument before the date. Um so if it's at 23 cents, I then could go on and I could say I want to spend, let's say, a thousand dollars. And because it's at 23 cents, that means I get more something than if it was at 65 cents, so it's more likely to happen. But what am I buying?

SPEAKER_00 5:27

Yeah, so you can think of it as um you're taking the other side of the bet, and the odds reflect this, right? And so if you are buying an event contract at 23 cents, then your upside that you realize on every dollar that you invest in that event contract is greater because you are going to get uh essentially winnings from the other side of that bet. And again, this goes back to the idea that these are peer-to-peer markets, right? So unlike other traditional forms of, let's say, sports betting, where there's a house and the house uh organizes a bet, assigns the odds, and then moves the odds around in order to get action on both sides of the uh bet. That's how traditional like sports betting works. And they will set the line in a way where, okay, we think the odds of this are X. We're gonna set the line at Y. And then if we have too much action on one side of it or the other, like I think the Eagles will win, I think the Chiefs are gonna win. Uh, those are uh football teams, Tashus. So like I'm grounding your uh your British understanding of his things.

SPEAKER_01 6:31

Alex, I'm just embarrassed for you that you're using last year's Super Powl finalists and not this year's.

SPEAKER_00 6:36

That's true. Uh, I'm a terrible sports better, I don't sports bet. So my examples are gonna be tragically out of date. Um that would be an example of what a traditional sports book would do. And they sit in the middle critically, right? And so they need to carve out like a five to ten percent uh margin because they're the ones you're actually betting against, and then they're sort of trying to balance out the risk they're taking by taking money from both sides. Prediction markets are much more of a peer peer-to-peer platform where for every dollar that's bet on one uh side of the outcome, other people can take the other side of that. And you can think of it as you are literally taking the dollars from the people who bet on the other side of it. And so if you are in the minority betting on something and you're right, you essentially take the money from the people who were betting on the majority of it. And uh if you are right and you're in the majority, you still get the winnings from that, but you get a smaller share of the winnings because there were more people betting that that was going to happen. Does that make sense?

SPEAKER_01 7:37

It does. And so you should think about it as with this alien example, you know, is there will the government um announce that there is like evidence of aliens by the beginning of next year? Yeah. If if it's at 23 cents and I I put a dollar down if uh there is alien life before it, you know, the government says this this turns out to be a true prediction, an accurate prediction. What do I get back for my one dollar?

SPEAKER_00 8:04

You get 73 uh 77 cents back.

SPEAKER_01 8:08

Do I also get my 23 cents that I paid?

SPEAKER_00 8:12

You get the premium on top of it. So you basically get the uh 77 cents back uh as the exchange on that transaction between what you invested versus what someone else invested on the other side of it.

SPEAKER_01 8:24

So it's this peer-to-peer platform, and presumably if more people are saying this is gonna happen, 23 cents, I'm gonna buy lots of those uh predictions, then the price rises because there's more people on the kind of no side. Is that how that works?

SPEAKER_00 8:40

Yeah. So the market kind of balances itself out. So as you uh as more people surge into yes, I think alien life is uh going to be confirmed by the US government before January 1st, 2027, then what happens is uh the price moves to reflect those changing odds because it's a mix of who's taken one side of the bet or the other. And so uh you will see this happen, right? Where uh based on either changing sentiment or sometimes based on like knowledge that certain people have that other people don't have, uh the market will move in a pretty extreme way. And it's related to volume, right? So if I come in and I bet$300 million that uh the US government will confirm the existence of aliens before the end of uh 2026, then the odds on that for anyone subsequently who wants to come into that market will be different, right? I would probably I don't know what the amount of money is that's been bet on that contract, but$300 million would probably move it from being, you know, 23 cents to probably over 50 cents because I'm I'm moving the market with my bet. And again, that's one of those things about these peer-to-peer markets that's a little bit different than a classic like sports book, where you know, with a sports book, it's the um sportsbook itself that's setting the odds. And if a big bet comes in on one side, the sportsbook is essentially taking the risk that they're not going to get wiped out on that. And sometimes they do, right? Sometimes someone finds a bet with a traditional sports book that's just badly priced, and they will come in with a huge amount of money. And if they end up winning, the sportsbook takes the loss in that case. Yeah. In this case, the the way these uh prediction markets work, there is no like middleman in the middle that's taking the risk. It's literally just we have X amount of contracts that are available to buy. And if someone comes in, they can dramatically move the overall odds on that, on that event.

SPEAKER_01 10:38

Interesting. And so there's just a certain number of contracts that can be bought. And so if you spend more money, you're still buying the same number of contracts, but you're spending more money, therefore you sort of changing the valuation of them.

SPEAKER_00 10:51

Yeah, you're you're essentially moving the market uh by adding more value into it. And so it kind of one of the things that's a discussion point with prediction markets a lot is um how much liquidity these markets have, because ultimately uh, you know, it's a it's a P2P platform, and so they have to balance out supply and demand, right? They need enough people taking one side of a bet in order for other people to take the other side, and these things don't scale up if you don't have enough liquidity. And so a lot of what you see uh prediction markets doing from a go-to-market perspective relates to like how do we bring more liquidity onto our platform? How do we bring more bets on both sides of these bets so that more people can can functionally gamble on these platforms? If you don't have sufficient liquidity, you just can't offer very big markets on these things because the amount of money that you're gonna win is just not very high because there's not enough people on the other side of the bet.

SPEAKER_01 11:51

Okay. Fascinating. And it also that example with the$300 million bet on the alien example brings to my mind certainly insider trading risks, which we'll put a pin in, but we must cover because I think that's really important with these. So that's super helper. These prediction markets, you know, peer-to-peer, anybody can create a yes or no statement online and sort of put it up there, and then people can start to buy these event contracts. Is how did prediction markets get started? How did they get become really popular? And then I want to talk about some of the legalities around these prediction markets. So actually, that sports example or the alien example, for example, those are perhaps not totally aligned with what prediction markets are supposed to be used for is my understanding. So let's start with how did prediction markets get really popular and then let's work through to the legality of it.

SPEAKER_00 12:44

Sure. So um in terms of how they got started, it's actually a very old idea. So it's been around for a long time, this idea that essentially uh the sort of opinions of a large population of people can be more accurate in aggregate than the opinions of even a small number of experts. So that's the fundamental idea, is this wisdom of crowds sort of philosophy. And that's that's been an idea that's intrigued mathematicians and economists and all kinds of different academics for a very long time. Prediction markets as we sort of understand them today, uh, really got their start in the 80s. There was a market called the Iowa Electronic Markets uh that was formed in 1988 that was sort of like an academic experiment, but the sort of designed to test this idea of can we predict real world uh events with some level of accuracy? Uh, again, from like an academic research perspective. Like, could we harness the wisdom of crowds by providing an economic incentive for people to bet on things in order to improve the accuracy of our predictions or our models? And, you know, they've really been kind of kicking around since the late 80s, roughly in the form that they are in today. Obviously, we didn't have smartphones and the ability to download the Calci app onto our device. So the form factor has changed a bit, but the idea of having an electronic market that settles event contracts with the goal of like attracting liquidity and attracting participation in order to harness that wisdom of the crowds, it's existed for many decades. Um, it's not until very recently the prediction markets have sort of hopped on the radar of the sort of general uh population. 2024 was really when that happened. And it happened because uh of the presidential election in the US. And um there was uh uh these prediction markets, and we'll talk more about the regulation, but uh, they're regulated by uh the CFTC, which is responsible in the US for uh regulating commodities in the commodities market. Um the CFTC had a rule that said that um prediction markets were not allowed to list event contracts for um political elections. And Calchi, uh, which had been in existence for a few years at that point, challenged the that rule from the CFTC, took them to court, ended up winning. And so uh it was deemed that election contracts were, I guess, in the public interest. And so um they were able to list the event contract for uh will Kamala Harris or Donald Trump win the 2024 presidential election? That uh single event contract attracted, I think, billions in uh overall trading volume on that one contract. And notably uh it was seen as being more reflective of reality and the actual outcome that we got than a lot of sort of professional polls that were done by pollsters or political experts. And so it sort of proved out the thesis that um enough liquidity on certain events can give you a better view into what might happen. And it also put these uh prediction markets on the map in terms of public consciousness, uh, volume of activity. And then they kind of went uh crazy from there, uh, both from a attracting venture capital standpoint. So now the largest platforms in this space are uh valued in the tens of billions of dollars, and uh from a regulatory perspective, uh much of which was ushered into existence uh after Donald Trump was sworn in as president. And uh we've had sort of a bit of a regulatory free-for-all in the US uh on prediction markets since then.

SPEAKER_01 16:33

Okay, that's super helpful. And then let's start talking about what the CFTC is supposed to regulate. Like what are prediction markets supposed to be used for?

SPEAKER_00 16:43

Yeah, so there's different arguments, but uh legally the prediction markets are uh regulated as a form of uh commodity uh or derivative that is uh specifically regulated under the Commodities Exchange Act, which was passed in the 1930s. Um it's a very old law, and it basically governs um the types of like derivative contracts that you might use, for example, if you're a farmer and you want to hedge the risk that you might not be uh making as much money from the corn that you're going to bring to market later this year. You could buy a derivative contract on a commodities exchange on the price of corn to hedge your risk in case uh the market comes in a little lower or a little higher than you were expecting. So it's really designed as a way to hedge real economic activity and real economic risks. And that's the sort of legal foundation that all commodities and all derivative contracts are built to sort of do. And that's uh broadly speaking considered to be the thing that has the most sort of like social utility and the thing that uh kind of guides regulation in this space. Now, uh, when the Commodities Exchange Act was written in the 1930s, uh obviously they didn't have any notion of what a prediction market was. They certainly didn't have any notion of a prediction market that existed on mobile phones that we all had access to 24-7. So the world has changed in some fairly significant ways uh since then. And it's the job of the CFTC, which is responsible for uh implementing and overseeing regulations based on the Commodities Exchange Act and other laws to uh ensure that as technology and the market evolves, we are sort of uh keeping true with the intent and the spirit behind that legislation.

SPEAKER_01 18:40

And that intent behind the regulation, according to lawyers that you've spoken to, is really that these derivatives, these things that we call predictions on these prediction markets are supposed to have some kind of economic impact.

SPEAKER_00 18:56

Correct. Yes. So um obviously, like we we can go through a bunch of examples, right? You can bet on prediction markets about whether the Federal Reserve will raise uh interest rates.

SPEAKER_01 19:08

Which has an economic impact, yeah.

SPEAKER_00 19:09

Which has a very clear economic impact. And so it would be in the interests of uh lots of different economic actors to have access to a market where they could hedge their risks associated with rates going up or down. Uh I think the same general things apply to like tariffs as an example. Will uh tariffs be uh overturned uh by the Supreme Court, which they were. Uh that has very clear sort of economic consequences for the market. Um, once you start getting into some of the more, let's say, creative or novel event contracts, then you start sort of testing that sort of risk management uh theory. So, you know, for example, uh you could say, uh, will the New England Patriots, there's your current Super Bowl, uh, will the New England Patriots um make it to the Super Bowl? Uh if you bet on that at the beginning of the year, there's an argument, perhaps, that uh business owners who own businesses near Gillette Stadium in Massachusetts, where the Patriots play, might have a vested economic interest in knowing whether uh it is likely that the Patriots will make it deep into the playoffs, in which case they'll have more home games, in which case they'll bring in more revenue, some of which will go to the local vendors around Gillette Stadium. As I recall from my last visit to Gillette Stadium, there's a lot of uh people who own houses who will rent out their front yards for parking for Gillette Stadium who are nearby. So they might have a vested interest economically in knowing uh or having a sense of whether uh there'll be lots of uh playoff games, and if there's not going to be, maybe hedging that risk by buying uh an event contract. That's kind of a silly example because how many people who rent out their front lawns for home games at Gillette Stadium really are gonna go under prediction markets to hedge that risk. But like theoretically, you could kind of squint and see that. Um, and then there's ones that just don't really make any sense at all, right? Uh, an example that a a lawyer uh friend of mine used when he was digging into this was uh you can take bets on whether an announcer in a game, uh like a national football game, for example, will say, uh, what a catch. I don't know that there's any rational economic risk that you could hedge if someone says, what a catch or not. Like that's just there's no real argument that that has any value to me. That crosses the line into gambling. And uh the prediction markets, the sort of controversy around them right now is that they are pushing their users and pushing the market much more towards gambling, with very little eye towards real economic risks that need to be hedged by the market and are just trying to bring as much volume. Volume onto the platform as possible. And that's notable because unlike traditional sports books, as we were talking about before, prediction markets make their money transactionally. And so the more bets there are on the platform, the more money they make because they take one to two percent of each wager. And so that's uh another sort of aspect to this that's important to understand.

SPEAKER_01 22:21

Interesting. So whether you win or lose, you're paying them. And that's how they make their money. Yes. Yeah. Okay. So that's there's quite a lot to unpack there. So the and I think the important way to sort of finish that narrative that you just got through, which is so helpful, is that my understanding is that now these prediction markets, the vast, vast majority of the volume on their platform is sports betting.

SPEAKER_00 22:48

Yes. So uh for Calci, uh, who's one of the big ones, in 2025, which is when they started adding sports betting, right? So we have the election in 2024. That kind of like takes the cap off of prediction markets, they attract all this volume and attention. 2025, they figure out that sports betting is something people love to bet on. Sports is by far the most popular thing to bet on. 2025, they start listing all kinds of event contracts for sports. They list the Super Bowl, they list um March Madness, they list uh this latest NFL season that we had. Like they list all kinds of different event contracts uh relating to sports. And uh Calchi's overall volume of bets, roughly 90% of it was due to sports. And so 10% is for everything else. And by the way, that everything else is not entirely inclusive of things that have a rational like risk management argument attached to it. There's still lots of silly stuff like, you know, will Mark Zuckerberg get divorced? Uh, are there aliens uh that will be revealed by the US government? Um, you know, will Jesus Christ return? Like there's all these bets on the platform that uh have a pretty tenuous, if no connection at all, to real economic events, but they are dwarfed. They and the more legitimate arguments like interest rates or elections or things like that are dwarfed by sports betting. That's about 90% of the volume.

SPEAKER_01 24:12

Okay. And so now we're getting into the concerns that arise from these prediction markets, and particularly on a state-by-state level. So my understanding is that the CFTC regulation, so calcium polymarketing, have been given approval to work federally across all 50 states of the US. And that is very different from a gambling site, your DraftKings or your you know, whatever your sports betting app of choices, which has to go state by state. Is that right?

SPEAKER_00 24:44

That's correct. So um in the US, and this is different, right? In uh like the UK, you've had sports betting legalized for a long time. In the US, it's new. So uh in 2018, the Supreme Court said that states individually could legalize sports betting. And um, so they started to do that. Uh not every state in the US allows sports betting, but many of them do. Um, and that is how if you wanted to be like a DraftKings or a FanDuel or a sports betting app that have really grown since 2018 as this wave of legalization has happened, uh, you need to get licensed in each state that you operate in. You're required to adhere to the rules of that state. Uh, those rules include things like protections for gamblers, uh, tools for gamblers who feel they have a problem, the ability to like exclude themselves from gambling if they feel like they can't handle it, uh, tax revenue that's collected by the states, some of which gets funneled back into treatment for gambling addictions, stuff like that. Um, and crucially, there's lots of states where you can't operate, right? Utah is a good example. Utah does not allow for sports betting. They seemingly, I would bet they would be one of the last states to ever even contemplate legalizing sports betting. Uh and so there's just restrictions on the size of the market and how you can operate within the markets that you're in. By contrast, uh in the US, we have like a wonderful sort of dual system uh where both states and the federal government sort of fight over who's allowed to regulate different things. Generally speaking, uh, if a legal activity is regulated at a federal level, that gives that activity federal preemption, which means that it can operate anywhere within the 50 United States. Um, currently, prediction markets are seen as uh a federally regulated activity regulated by the CFTC, and that means that they can operate nationally and they don't have to play by the same rules that uh traditional sports books operate in. If you are an 18-year-old man who's going to Temple uh on Sunday morning in Salt Lake City, Utah, you can now bet on the NFL games happening on Sunday uh in Temple on your mobile phone while you're there. That is very much a contravention of everything that Utah wants and that the citizens of Utah have voted for with their elected representatives, but it is now enabled through this uh federal allowance of sports betting through prediction markets.

SPEAKER_01 27:18

Okay. And so my guess is some people are pretty unhappy about this. Maybe some states, maybe the fan jewels and the draft kings of the world. What's the situation? Are there any legal actions against these prediction markets right now?

SPEAKER_00 27:32

There's a ton, yeah. So um kind of coming at it from a few different angles, um the states are not happy about this. And it doesn't really matter what their position on sports betting is, none of them like it, right? So if you're a state like New Jersey and you legalize sports betting early on, it's a major source of state revenue. Uh, this is a threat to your tax revenue and your ability to regulate an activity in a way that you think it should be regulated. And um, I guess you could say that's slightly a bit of a cynical argument on the part of the states, because it's not like they're not allowing sports betting. They're just wanting their cut of sports betting. I don't think it's quite as cynical as that because they do take steps to help. Like in New Jersey, they have a hotline you can call with people that you can get help from if you feel like your gambling is becoming problematic. You know, CalShi and Polymarket don't contribute money to a hotline that you can call, right? And so uh the states that have legalized it feel like it's being taken away from them. A lot of them have sued to stop uh Calci and Polymarket and others from operating prediction markets within their states. Um, but this also applies to states that haven't legalized it, right? Utah doesn't like this either, not because it's taking tax revenue away from them, but because it's bringing in activity to their citizens that they don't feel is in their best interests. So they are also planning lawsuits or initiating lawsuits against the prediction markets. Um, the current leadership at the CFTC has said uh most recently that they are going to fight very hard on behalf of prediction markets to defend their right to bring sports betting to 18-year-olds in Utah. Um, so they are going to actively take the side of uh the prediction markets. That's not terribly surprising because most federal agencies don't like to have their powers of preemption challenged by the states. So they are weighing in on that side. Um, and then obviously there's huge issues if you are like a DraftKings or a fanDuel, because you are now competing with apps that are very well designed, very like slick user experiences, they're pouring a ton of money into marketing and trying to get market share and attention from users. And critically, they can operate without any restrictions in pretty much every state. And so you're really fighting with one hand tied behind your back if you are DraftKings or FanDuel, which is why those apps have all initiated the process of becoming prediction markets themselves. And you can think of it as them hedging their own risk by basically saying, look, if um a future version of the CFTC comes in or Congress comes in and says, hey, you can't do sports betting through prediction markets, which is very possible that could happen. If that happens, we're fine because we can go back to our old model of being licensed state by state and nothing really changes. But on the off chance that this massive regulatory loophole stays open, we need to be a part of it too. And so they are all in the process of launching their own uh CFTC regulated uh prediction markets in order to enable sports betting that way as well. And it's kind of like a, you know, um uh cannibalize yourself before someone else cannibalizes you, type of argument from their perspective. Um, and then the third sort of group that's throwing up objections to this are just consumer advocates. Uh, I would sort of uh put myself broadly speaking within that category, but um, there's a lot of folks who just think that the value of prediction markets having um a lot of liquidity and a lot of activity and the whatever social benefits might come out of that are not worth the costs that you have to pay societally for that activity. And um, you know, it's an interesting argument because um, on the one hand, like to put it in very specific terms, you might think it's valuable to hedge the risk of some obscure economic activity. But in order to get really good data on that obscure economic activity, you have to have enough liquidity hanging out on your platform that people might want to bet on that activity. But in order to get that liquidity to your platform, you have to offer fun things to invest in, like sports betting. And so if you were genuinely as a prediction market saying, look, we view our role as just creating great signal and reliable data that the market can rely on to hedge risks and to predict what's going to happen in the future, you could view sports betting as just a lure to bring more liquidity to the platform to facilitate those higher value bets. And that could be how you think about it. But the cost is, and you you illustrated it very well, there's significant like economic costs to bringing sports betting to people who uh maybe are not well suited to handle it. And while lots of people can handle sports betting as just another form of entertainment that they engage in casually, uh sort of gambling addiction is seen by behavioral science experts as one of the most sort of damaging uh addictions and one of the addictions that's most difficult to treat. And just to put a very fine and somewhat dark point on it, um it has consequences for the broader household in which the gambler operates in as well. And so, you know, they've also done academic studies that have found that when you legalize sports betting uh in a particular state, rates of like intimate partner violence go up, rates of child abuse go up. And so the question is really are the benefits of these prediction markets in terms of informational value and the ability to hedge risks worth those sort of social consequences?

SPEAKER_01 33:05

That was that's excellent. That gives us so much to dig in on. And I think one of your last points there of you know the sports betting being seen as a way just to bring liquidity to the platform to enable the other economically valuable predictions to be made. That kind of just like it completely goes away as uh as there being any other option but to do that because they've taken so much VC money. These Calcium Polymarket have taken so much VC money that they simply have to find ways to bring liquidity. So they they can't not, with their business model and their cap table now, do anything other than like you do use sports betting to attract liquidity.

SPEAKER_00 33:47

Yeah, I mean it's the like the the Iowa electronic markets was a long time ago. And that's like a cute little academic experiment. And to your point, there's no incentive for them to grow, right? And so like that was like, hey, does this work on a small scale to help researchers figure out what's gonna happen in the future? Yes, it does. Um, but if you're a VC backed business that has to grow and has to generate revenue and has to show sort of results to your investors, you're very quickly gonna sort of lose the plot a little bit and you're gonna start sort of just adding whatever bets will bring more liquidity onto the platform. And the other point I'll just make really quickly is uh prediction market advocates will argue that prediction markets are better than traditional sportsbooks because uh you're not there is no house. You're not betting against the house with a prediction market, you're just betting against other people trading on the other side of the bet. However, the challenge with that argument is that um, in order to attract growing amounts of liquidity onto these platforms, um the prediction markets have to appeal to institutional traders, right? So the the where the real money is, is Jane Street and Citadel and these like investment firms that specialize in just finding alpha in various corners of the market. And you can think of them as like deeply amoral entities that just exist to like sort of arb away any sort of like loopholes or opportunities in the market, any of inefficiencies in the market wherever they find them, uh, with no real regard for any like social consequences at all. And if you're a prediction market, you want those traders to come onto your platform, but you have to feed them alpha and you have to feed them sort of uh arbitrage opportunities. And the best arbitrage opportunities come from retail traders who have no fucking clue what they're doing. Sorry if I'm not supposed to swear on your podcast.

SPEAKER_01 35:34

You can totally swear, it's alright.

SPEAKER_00 35:36

Uh and so you want to bring in like fish and you want to bring in as much fresh fish as you can. And so, like, sports betting is a great way to do that. Uh, people who want to make fun bets about will the government reveal the existence of alien life accomplishes that. Uh, bets on popular culture items that were in the news do that. And if you look at what the prediction markets do from a marketing perspective, they really lean into this idea of like, hey, what a fun, wacky bet. You should come express your opinion on this on CalShi. And they almost describe it to their users in some senses as like, come be a part of the conversation on Calci. Uh, come be a part of the current cultural or sports conversation on this platform. Express your opinion. It's not, you're not really expressing your opinion if you're not putting money behind it, is kind of the way that they they frame it. But on the other side of that, there are institutional traders who are looking for opportunities where people don't know what they're doing and are going to take their money. And if you look at the early reporting that's been done on sort of what your expected value is, just betting on Calci or Polymarket, you're almost overwhelmingly likely to lose your bet. And so it's a very asymmetric market in terms of the outcomes that investors get, depending on how sophisticated they are.

SPEAKER_01 36:56

So that's really interesting because with betting, you know, you go to a casino or you do a do a bet on a sports game through an app.

SPEAKER_00 37:03

Yeah.

SPEAKER_01 37:04

There's that saying, you know, the house always wins. And generally, like if you have much sense with any gambling, you understand that over time this corporation will probably make a lot more money than you will. And what's interesting about these prediction markets is there's no corporation on the other side. It's not that the house always wins, but it is a bit more that the rich always win because the rich are the ones that have their money with the Jane Streets of the world. Yeah. And they are the ones that can pay researchers and analysts to go find all these loopholes and dig up some data that might steer them one way or another with a prediction. And then the the regular consumer on the street coming on the prediction market, it's still a case of it's not the house always wins, but it's probably the person on the other side of the bed always wins because you're just a consumer and they are probably some large institution with a lot of money behind them and a lot of data.

SPEAKER_00 38:01

Exactly. I mean, it's not dissimilar to like payment for order flow with like a Robin Hood, right? Where it's like, you know, one side of our business is making investing, making trading really attractive to retail. And then the other side of our business is selling the ability to bet against all of those bets to really sophisticated market makers or market participants who are looking for arbitrage opportunities. And so all markets that grow really fast in retail, that's basically the way that you monetize those. And, you know, it's honestly not dissimilar to the way that like P2P lending platforms evolved in the 2000s and 2010s, right? They started as true peer-to-peer platforms where someone would come on to borrow money, someone would come on to invest in borrowers, and they would be matched up. And it was just like purely a peer-to-peer platform. But what the lending clubs and the prosperous of the world discovered, same way that you know anyone else does who's building a peer-to-peer platform, is to make it sustainable and to sort of get to that growth trajectory that you're looking for, you have to bring in institutional capital. And as soon as you bring in institutional capital, the incentives change. Now, in the case of lending, it's not as bad because at least the borrowers are getting money back out of it. But when it's betting or investing, when the two sides of the market are very unequal in terms of their informational advantages and their level of sophistication, it kind of turns into a bloodbath. And um, you know, to your point about like James Street and Citadel and you know organizations like that, they are actively hiring trading desks for people to trade on prediction markets. So like they are staffing up those exact functions because they see a new source of alpha in the market that they can go after.

SPEAKER_01 39:46

And that I it feels even more scary than always playing against the house and assuming the house will win. Because in that situation, it is clear who you're playing against. It is this well-known phrase you go to Vegas, house always wins, like you're probably gonna lose some money, but you're having fun.

SPEAKER_00 40:03

Yeah.

SPEAKER_01 40:04

But that's not clear when it's pitched as a peer-to-peer lending uh trading platform. So I think that's like very interesting from a consumer perspective. All of this also leads me to something you said earlier, um, prediction markets started based on sort of this concept of the wisdom of the crowds. And something that comes to my mind when you or it came to my mind when you said that was is that still true when there is so much wealth inequality in America? Because the wisdom of the crowds, when there are other incentives, not just the the seeking of truth, you know, when it really is just about making money, off ridiculous things like, you know, will the government declare that the existence of aliens before the end of the year, or um will Mark Zuckerberg get divorced? When you are trying to understand the wisdom of the crowds there, it seems so open to manipulation. There are so many people with so much money who can just tilt the scales on that kind of bet. And therefore it's no longer reflective of the wisdom of the crowds. It's reflective of the wisdom of whoever has the most money to move the market the most.

SPEAKER_00 41:18

Yeah, I think that's right. And you know, I think that it just sort of that that wisdom of the crowds idea sort of presupposes that the crowd is one monolithic equal block of the city.

SPEAKER_01 41:31

Each with like one token to bet. Yeah.

SPEAKER_00 41:34

Right, right. It treats it more the way that we think of like elections or anything else, where it's like everyone gets an equal say in doing this, everyone has equal information, everyone has equal influence, and this is going to be like a fair game. And, you know, what we know is that that's obviously not true. Um, you know, if you want to get into insider trading, we can talk about that. But like the reality is different participants in these markets have different information, they have different resources that they can bring to bear uh to move the markets, to manipulate the markets. And so they fundamentally end up being something uh unequal. And, you know, it's it's a real concern because then you're getting into issues around uh corruption and sort of insider trading, market manipulation. Uh it probably feels relevant at this point to mention that uh Donald Trump Jr. is a strategic advisor to both Calci and Polymarket, which I didn't know you were allowed to be a strategic advisor to companies that compete with each other, but I guess for certain people you can. Um that likely has paved the way for them to get uh favorable regulatory treatment uh under the current administration. And so you just worry that, like, even though these things are presented as wisdom of the crowds, completely unbiased, we're just letting the market speak. Uh, much like capitalism, on a large scale over a long period of time, those things tend to be true. On a shorter scale, they tend to express themselves as the natural inequalities that exist between people today. And I think that's happening on prediction markets right now.

SPEAKER_01 43:07

So let's get into insider trading. Have there been any concerns about that? I mean, gambling websites, sports betting, they have so many controls to try to stop insider trading. And it still happens, but it is it is more rare now. Have there been any issues with this on the on the prediction markets?

SPEAKER_00 43:23

Yes, there has. Uh, there have been a lot of concerns about insider trading. There have been examples that um have been publicly reported on. It's interesting, you know, because a lot of this data is fairly like out in the open. And so, like, um, using Polymarket as an example, it's a crypto native prediction market. So, like all the data and all the volume is like available for anyone to analyze uh because it's all on the blockchain. And so you can see, for example, like, hey, um uh you know. There was a event contract available on um sort of would the US uh invade Venezuela, uh, which um there's a whole other sort of realm of legal questions around are you allowed to have contracts that relate to certain activities like war or various things like that. Um but on uh polymarket there was a a contract for that, and you can see new users, new wallets being set up like the day before the US has a um you know uh intervention in Venezuela to kidnap the uh president of Venezuela, and they bet a tremendous amount of money on yes, the US will invade uh Venezuela. There's pretty clear signs that there have been lots of examples of insider trading. Um, another example was um the Israeli uh authorities uh arresting several Israeli army reservists for uh allegedly participating in polymarket bets on future Israeli military activity. That doesn't seem great. Um, there are other examples where it's more a question of like, well, that was weird. I wonder why that happened. Is that just a coincidence or is that the result of insider trading? So, for example, um the uh press secretary for the Trump administration ends her press conference uh 30 seconds before uh a bet on one of the prediction markets says that the uh uh press conference will end. Was that a coincidence? She seemed like she was kind of rushing and just sort of abruptly stopped and then ran off the podium and it was right before this time.

SPEAKER_01 45:46

Like no way.

SPEAKER_00 45:47

Yeah, and it's like was that I mean it could have totally been a coincidence, or it could have been she had wagered on that happening, or it could have been one of her friends or family members had wagered on it, or it could have been she was being extorted by someone who had wagered on that. Like, we don't know. And in some senses, like the it it ironically, even though prediction markets are designed to help us ostensibly like get a better handle on reality and what's gonna happen, in some senses it causes us to question our reality because there'll be these things that happen where you're like, that's weird. And then you sort of wonder did that happen because someone was trying to manipulate a prediction market? Did that happen because someone was trading on inside information prior to a prediction market contract being fulfilled? Like, we just don't know. There have been several instances, not a ton, but a couple, where the prediction markets themselves will um take action on insiders doing insider trading. So there was a couple examples recently from Calci. One was a producer who works for Mr. Beast doing like video production uh relating to something having to do with Mr. Beast that was uh available as a prediction.

SPEAKER_01 46:59

Um, but the fine was like some thousands of dollars and being banned for a few months, but presumably this guy makes a lot of money working for Mr. Beast. So, like Well, right.

SPEAKER_00 47:10

And like the other thing that's kind of funny is they're like, we're fining you. It's like, well, you're not the government. You can't like how are you gonna find them? Like fining just means confiscating any money that you might still have on the platform. But like if you've taken the money off the platform, it's like they can't come arrest you or something. And so it's it's a little bit unclear as to how much these platforms can police this inside information, and honestly, how much they want to too is the other thing. Because again, like it's kind of funny, but it's like if you believe that you are building a I'll I'll use the language they use to describe themselves, like civilization scale truth machine, like that's sometimes how they describe prediction.

SPEAKER_01 47:50

Yes.

SPEAKER_00 47:51

No, yeah, it's pretty grandiose. Uh, and um, like the way they describe themselves, if that's what you actually think, if that's what you think your job is, that's what you're doing for society, then isn't like insider information good? Like, doesn't that help resolve the contract in a more accurate way? And so there's kind of this tension between what should we do to be a good, fair market participant, and what should we do to maximize the use of this platform so that the data coming out of this platform is as valuable as possible. And to a degree, those two things are a little bit in tension with each other. Um, interestingly, Calci I would say is the more sort of like regulated and sort of like well-behaving of the two markets. And so polymarket is more of an offshore market. They really are very loose as it relates to like KYC tracking inside information, trying to crack down on that behavior. So you tend to see more of the kind of wild, interesting examples of insider trading on uh polymarket, but it absolutely happens on CalShi as well, probably at a level that's way beyond what they police today.

SPEAKER_01 48:57

Oh, wow, that's amazing. That feels a little bit like the free speech uh obsessives who don't who want free speech apart from when it's against them.

SPEAKER_00 49:06

Um free speech absolutists will say there's no restriction that should ever be placed on free speech. And you'll give them use cases where you're like, well, what about this? And they're like, nope. And you're like, what about this? And they're like, and they just like they believe free speech 100%. That fraction of people exist in the prediction market space too, where they're like, these are these are just markets that exist to sort out what's going to happen in the future. We should have we shouldn't be like putting our fingers on the scale at all. Obviously, that has enormous consequences for society, for what we think is fair. I think even the current CFTC that sort of loosely regulates these markets doesn't like the level of like insider trading that you see on these. Um and then the last thing I'll say on this that's just important to note is um traditionally, with like sports betting as an example, um, it's a very binary outcome, right? Uh the Cavaliers won, the New York Knicks won. Like you know who won, you know who lost, you know how many points uh you know Evan Mobley scored. Like you know these things. These are known quantifiable binary facts. One of the challenges with prediction markets is that they offer contracts on things that don't have clear uh rules all the time about uh whether something will resolve one way or the other, right? So, like, for example, a very recent example with the US action, US and Israeli action in Iran was a question of um whether uh the Ayatollah would be removed from power or would not be in power anymore. Um, Kalshi does not offer contracts that resolve on the death of a foreign leader. And so um they did offer contracts on whether the Ayatollah would be removed from power or would not be uh would be like stepping down from power, but not on his death. That's a pretty weird distinction to draw, right? And it's pretty hard to make clear to your users, uh, okay, under these circumstances, this contract will resolve to yes. But if this person who's in their 80s happens to die and that's how they're removed from power, then this contract will resolve to no. Like that's a very ambiguous and very difficult to sort out like settlement for that contract. And you saw over the weekend uh when all of this stuff happened and when the Aitola was killed, that's exactly what people were complaining about on Calci. And the CEO had to come out multiple times and clarify and then re-clarify and then re-clarify what their rules were on that contract because people were complaining that, like, hey, I bet yes. And um, I got money into this contract before it closed, before it resolved. And now you're telling me that I'm not gonna get the winnings that I thought I was gonna get. And so um, where prediction markets meet the real world, it becomes trickier. Another example was um Time magazine, they always do their like time person of the year. Um, well, people thought perhaps the time person of the year might have uh something to do with AI. And so people were betting, like, might be Sam Altman, might be Elon Musk, might be someone else. And then it was the builders of AI, and like, okay, what is the builders of AI? Was that something you could pick? No. You could pick AI generally. Does that equal builders of AI? Some platforms thought yes, some platforms thought no. So as you expand into these other areas, uh, they're not binary or easy to resolve, and that creates more friction as well.

SPEAKER_01 52:47

Okay, so I want to I want to try to make we've talked about a lot of the negatives or the concerns around these prediction markets. What are some of the positives? What are some of the pros of these prediction markets? Like why are they good? What do they do for people, for markets?

SPEAKER_00 53:02

Sure. Well, let's talk about the 10% that's not sports betting, right? Because I think sports betting has high social costs and almost no utility to the broader world. Um, but for the 10%, I think there is plenty of use cases where this does generate valuable data, right? So um we saw with the 2024 presidential election, uh professional pollsters were underweighting the chances that Donald Trump was going to be elected. Uh prediction markets had a more accurate feel for that. And so this idea, this wisdom of the crowds idea, does actually uh prove out to be true in a lot of cases. Like it does tend to generate more accurate predictions in some places, not universally, but in some places it does tend to produce more accurate uh predictions. And as a baseline, if we're creating more accurate predictions, there should be ways that that can be packaged for responsible risk management. And I'll give you one other example. Um, prediction markets have started partnering with the providers of data on home prices throughout the US. And you could imagine a world in which uh it was presented to a homeowner the ability for them to hedge their risk of owning a home in a market where values for their home might go down by being able to essentially bet on that and hedge that risk personally, right?

SPEAKER_01 54:26

Um whoa, that feels like we're gonna have an 08 situation.

SPEAKER_00 54:32

Well, I mean, that's the that's the concern, right? Is that like how how much does people participating in these markets move these markets or cause things to happen, right? And so like it's really hard. Like, would you like to be able to buy insurance on the possibility that your home price goes down rather than goes up? On an individual level, you might want to, right? Like that might be something that you would want to hedge your risk on. Now, there's a question of will consumers actually do that? How can you present that insurance to them in a responsible way that's not predatory? Like on and on and on. But as a as a primitive that you could build a product around accurate data and the ability to wager on outcomes for home prices, you could see becoming the primitive for some type of insurance or risk management product in that space. But as you illustrated, that also comes with potential large-scale societal downsides. Like, what if we're all betting on the housing market going up? You remember during 2007, 2008, a big thing that created a lot of the problems was all of the sort of synthetic investing activity that took place on top of mortgage-backed securities? Um, like that's what caused the market to blow up at the scale that it did. This could lead to something similar. So everything you look at with prediction markets, it's like a question of is this valuable for this particular use case? Probably on a small scale or for an individual, yes, or at least maybe. Is this something that should exist at a large scale with tons of volume running through it, particularly if it's not very carefully regulated? Almost assuredly, no, and there's probably going to be consequences that come out of that. And so I think to answer your question, there are things you can kind of squint at and go, yeah, I could see that being useful. But how these things get operationalized and the scale they get operationalized at and the rules that exist to make sure that they're fair, that's the stuff we haven't figured out yet.

SPEAKER_01 56:28

Oh wow, that's that blows my mind. Um I want to end talking about the grocery store. What is the New York-based grocery store?

SPEAKER_00 56:39

So uh this was like a little promotion, I guess, that um Calci and Polymarket ran uh recently, where uh I'm trying to remember, I think was it one of them opened up a grocery store in New York and gave out free groceries to people living in New York. The other one basically did a version of that, but they like donated money to the food bank or something. And they both happened on the same day, which was kind of weird. Um I believe it was mostly like A, a publicity stunt and kind of a marketing stunt, and B kind of a way to maybe soften up New York politicians and regulators who maybe might otherwise have unfavorable opinions about prediction markets. But you know, it's interesting. Um, the other thing I've learned the hard way with this stuff is there's a certain level of like advertising and marketing and expenditure that a company can have before it becomes like unsustainable, right? So like marketing spend tends to kind of find its level. And that's why people advertise on television, but they don't advertise on fortune cookies in Chinese restaurants, as a real example that I've encountered in the past. Uh, most people don't have fortune cookie advertising money. Um, but when you see someone advertising on a fortune cookie in a restaurant, um, usually what that tells you is they have way more money than everyone else. And they think it's a good idea to spend that money advertising in unique and unusual ways to reach into parts of the market. Um, that example is a real example, by the way, because before FTX blew up, I got a fortune uh from FTX that was sponsored by FTX and my fortune cookie. Um and that was always just like a signal for me that like something is wrong with this company or this market if money is like leaking into at this place. Prediction markets are the new version of this, where these markets, as you said before, they've raised a ton of venture capital, they're valued very, very highly, um, and they're just raking in money from all of these bets that they're enabling in a very sort of unregulated fashion. We are going to see them sort of have money spill out into weird things where you're like, Calci has a grocery store? What is that? And usually the answer is they have more money than they know what to do with. And so someone came up with this creative stunt to do, and that's kind of uh how they're spending their money.

SPEAKER_01 59:03

That felt like a really ill, ill it put an ill taste in my mouth that one, because it felt to me like the sorts of people who might need free groceries in New York might well be the people who have gone and lost their money on the prediction markets.

SPEAKER_00 59:17

Yeah, I didn't think the optics of that were particularly good. And um, I guess the other thing I'll say just quickly about these prediction markets is um their tone and sense of taste uh is probably well calibrated to the sort of corners of the market that they go after, but they will often leave a bad taste in your mouth. Uh I believe it was Calchi who got into some trouble for running an advertisement on social media where they sort of framed prediction markets as a way for young people to pay off their student loans. Um and it's it's stuff like that. Wow. Uh like we have words for that in uh financial services, right? Like UDAP is a term that gets used to describe unfair, deceptive acts and practices. You see that kind of stuff all the time in prediction market land right now. And again, it's a lot of different things.

SPEAKER_01 1:00:07

And let me let me guess those sports betting sites cannot do that with their regulator.

SPEAKER_00 1:00:12

Right, right, right. And so like the the regulatory sort of gray area that these prediction markets are operating in, it just sort of creates this like Wild West environment. And um, you know, I'll I'll end by saying the thing I worry about is, and we touched on this before. This stuff is being presented as investments, right?

SPEAKER_01 1:00:32

The commodities uh market it's being presented as investments, not just gambling. Investments. Correct.

SPEAKER_00 1:00:40

Yeah, so like if you go into Robinhood, Robinhood will present sports betting, because they've embedded prediction markets into their platform, they will present sports betting as a form of investing, right alongside investing in crypto, investing. You would want to hope so, yes. Uh I don't think that that is coming anytime soon, unfortunately. And the thing I worry about is prediction markets continuing to move further and further down the stack. So if prediction markets start as hey, it's an app, download it onto your phone. At least you can sort of see what it is and you can make a judgment for yourself as a consumer whether you want to take that on or not. Then they partner with Robinhood and Coinbase. And so now instead of downloading the Calchi app, I log into Robinhood or Coinbase, which I might have downloaded for more legitimate investing purposes. And now, right alongside the other things I was previously investing in, are prediction markets presented as a way to diversify my risk and to invest in other asset classes. They usually use the word asset classes to invest in sports prediction markets. And then you kind of go, okay, that's not great, but what's going to happen eventually to CalShi is you know, Robinhood and Coinbase are gonna build their own exchanges so that they don't have to do it in partnership with CalShi and they'll do it themselves directly.

SPEAKER_01 1:01:58

And which is much easier because you only need one license versus 50.

SPEAKER_00 1:02:02

Right, right, right. And so pretty soon Robinhood and Coinbase are gonna do this directly, which isn't great, but is bad for Calci. So then Calci starts partnering with Alpaca and uh Drive Wealth and Apex, which are brokerage as a service providers that work to embed investing inside of FinTech apps. And so at some point in the near future, you could see, you know, uh OnePay from Walmart as an example, offer prediction markets as a part of their fintech super app that they offer to Walmart shoppers who are people who generally are lower income, living paycheck to paycheck, and this is going to be presented to them potentially as just another investing option. And that's the thing I worry about is you know, like my kids are not old enough for this, but I don't want them growing up in a world where prediction markets are presented as a rational form of investing.

SPEAKER_01 1:02:57

Yeah. Wow. Okay. Alex yes or no, are predictions still are prediction markets still around on uh on the first of January 2030?

SPEAKER_00 1:03:10

That's a good question. Um I would say they will still be around, but I would say that they will be much more tightly regulated than they are today, and they will likely be uh either heavily restricted from or entirely prohibited from offering certain categories of event contracts. Uh sports, of course, being the one that everyone's fighting over right now.

SPEAKER_01 1:03:32

Uh it gives me hope that you are such an optimist. Um, Alex, this was totally fascinating. Thank you so much for joining me. Um and for everyone listening, if you enjoyed this, please share it with your friends and colleagues and subscribe on Apple Podcasts or Spotify. And I will see you next week for another episode of In Control.