Prediction Markets: Regulatory Gaps, Insider Risks, and Perverse Incentives

Key Quotes

"From the newsroom of The Washington Post, this is Post Reports. I'm Martine Powers. It's Wednesday, January 7th. I cannot stop thinking about this strange side story to the news out of Venezuela. Is this evidence of some kind of national security leak? But also, how is it possible or even legal that someone could bet on the capture of a world leader?"

Martine Powers expresses bewilderment regarding the legality and potential implications of betting on geopolitical events. Powers questions whether the bet on Maduro's ouster constitutes a national security leak, highlighting the unusual nature of such a wager.

"It's definitely a completely wild side story to this whole episode. A couple years ago, you probably wouldn't have been able to bet like this, but these prediction markets have grown dramatically in the last two years. They went from being this niche, very tiny corner of the markets to something where we're now seeing more than $3 billion a week in bets on some of these platforms."

Andrew Ackermann explains the rapid expansion of prediction markets, noting their growth from a niche interest to a significant financial activity. Ackermann emphasizes the dramatic increase in weekly betting volume, indicating a substantial shift in their market presence over a short period.

"So there are websites where people can place bets online on pretty much anything: the outcome of sports games, geopolitical events like elections, what happens to characters in random TV shows. There are basically two dominant markets here. Kalshi, which is overseen in the US, it's regulated here, and it's not quite the free-for-all of the second market, Polymarket. That's where this Maduro trade happened, and it's offshore, meaning it's not designed to be used by Americans because it's not regulated here. Polymarket is kind of seen as the Wild West here."

Andrew Ackermann describes the broad scope of prediction markets, detailing the variety of events on which people can bet. Ackermann distinguishes between regulated platforms like Kalshi and the less regulated, offshore market of Polymarket, where the Maduro bet occurred, characterizing the latter as a more open and less controlled environment.

"Yeah, I mean, and they've been attacking these boats in the Caribbean, but nobody, nothing to suggest that this was going to reach this climax like right on this morning of January 3rd. Correct. Nothing public. And so it's very suspicious. Do we have any idea who this person is who made so much money off of this bet?"

Martine Powers points out the lack of public information or indicators suggesting the impending capture of Maduro. Powers finds the situation suspicious, given the absence of public knowledge about the operation, and questions the identity of the individual who profited significantly from the bet.

"Basically, in the stock market, you have to have fair disclosure when it comes to securities that are traded on stock exchanges and elsewhere in this country, and you just don't have those rules in this space. These are basically futures contracts, which means they're overseen by this agency called the CFTC, the Commodity Futures Trading Commission. It's a very small agency. I mean, this is like such a fast-growing market. They haven't had time to really write rules for it. I mean, they don't really have the bandwidth to oversee it."

Andrew Ackermann contrasts the disclosure requirements in the stock market with the lack of similar rules in prediction markets. Ackermann explains that these markets are overseen by the CFTC, a small agency that has not yet developed comprehensive rules for this rapidly expanding area, suggesting a regulatory gap.

"Well, the other thing is, you know, call it whatever you want, prediction market, gambling markets. If you're investing in the stock market, you're putting money into stocks that over time are likely to increase in value. With this, that's not necessarily the case. These are binary markets. You either win or you lose. You don't get interest. Your price doesn't go up or down really. It's yes or no. And those aren't really traditionally thought of as investments."

Andrew Ackermann differentiates prediction markets from traditional investments like stocks. Ackermann describes these markets as binary, where outcomes are strictly win or lose, lacking the potential for gradual value increase or interest accrual characteristic of investments, and questions their classification as such.