6 Answers sorted by
Jun 08, 2023
4428You are right that by default prediction markets do not generate money, and this can mean traders have little incentive to trade.
Sometimes this doesn't even matter. Sports betting is very popular even though it's usually negative sum.
Otherwise, trading could be stimulated by having someone who wants to know the answer to a question provide a subsidy to the market on that question, effectively paying traders to reveal their information. The subsidy can take the form of a bot that bets at suboptimal prices, or a cash prize for the best performing trader, or many other things.
Alternately, there could be traders who want shares of YES or NO in a market as a hedge against that outcome negatively affecting their life or business, who will buy even if the EV is negative, and other traders can make money off them.
Sometimes this doesn't even matter. Sports betting is very popular even though it's usually negative sum.
Yes. PredictIt used to attract a lot of "dumb money" - people who just wanted to bet on their favorite candidate (or against disfavored candidates). They also used to run weekly markets on polling averages and things like the number of times Trump would tweet that tended to attract people who just wanted to do some skill-based gambling, whether they actually had the skill or not.
PredictIt charges high transaction fees with no outside subsidies, so all o...
Thanks for the excellent answer!
On first blush, I'd respond with something like "but there's no way that's enough!" I think I see prediction markets as (potentially) providing a lot of useful information publicly, but needing a flow of money to compensate people for risk-aversion, the cost of research, and to overcome market friction. Of your answers:
- Negative-sum betting probably doesn't scale well, especially to more technical and less dramatic questions.
- Subsidies make sense, but could they run into a tragedy-of-the-commons scenario? For instance, if a gr
Jun 08, 2023
41In theory, there can be information-seekers who subsidize either the operation of the market, or the payout pool for specific questions, or provide bonuses for profitable investors/market-adjusters.
But fundamentally, there's no "outside" source of income to participants, like there is for stock ownership (theoretically; there's a LOT of companies who've never paid a dividend).
Jun 08, 2023
40It’s not zero net value because there’s information produced, and also it’s fun. A more rational alien species that does not find risk enjoyable would have less accurate prediction markets (although without such thing as “gambling” maybe their markets are actually legal and thus more accurate.)
At manifold we haven’t really found a good way to use the information value yet. Subsidization doesn’t lead to increased activity in practice unless it makes the market among the top best trading opportunities. Pay for views has been much more effective as a “pay for information” method than subsidy. Most users are bettors rather than viewers. It’s good that we’re good at converting people, but without a long tail of lurkers we aren’t generating a lot of value from the information itself.
Cool to hear from someone at manifold about this! I agree the information and enjoyment value can make it worthwhile (and even pro-social), but if it's zero net monetary value, that surely limits their reach. I appreciate prediction markets from a perspective of "you know all that energy going into determining stock prices? That could be put towards something more useful!", but I worry they won't live up to that without a constant flow of money.
...Subsidization doesn’t lead to increased activity in practice unless it makes the market among the top best tradin
Jun 08, 2023
30There is a situation in which information markets could be positive sum, though I don't know how practical it is:
I own a majority stake in company X. Someone has proposed an action A that company X take, I currently think this is worse than the status quo, but I think it's plausible that with better information I'd change my mind. I set up an exchange of X-shares-conditional-on-A for USD-conditional-on-A and the analogous exchange conditional on not-A, subsidised by some fraction of my X shares using an automatic market maker. If, by the closing date, X-shares-conditional-on-A trade at a sufficient premium to X-shares-conditional-on-not-A, I do A.
In this situation, my actions lose money vs the counterfactual of doing A and not subsidising the market, but compared to the counterfactual of not subsidising the market and not doing A I gain money because the rest of my stock is now worth more. It's unclear how I do compared to the most realistic counterfactual of "spend $Y researching action A more deeply and act accordingly".
(note that conditional prediction markets also have incentive issues WRT converging to the correct prices, though I'm not sure how important these are in practice)
Jun 08, 2023
3-7In a good prediction market design users would not bet USD but instead something which appreciates over time or generates income (e.g. ETH, Gold, S&P 500 ETF, Treasury Notes, or liquid and safe USD-backed positions in some DeFi protocol).
Another approach would be to use funds held in the market to invest in something profit-generating and distribute part of the income to users. This is the same model which non-algorithmic stablecoins (USDT, USDC) use.
So it's a problem, but definitely a solvable one, even easily solvable. The major problem is that prediction markets are basically illegal in the US (and probably some other countries as well).
Also, Manifold solves it in a different way -- positions are used to receive loans, so you can free your liquidity from long (timewise) markets and use it to e.g. leverage. The loans are automatically repaid when you sell your positions. It is easy for Manifold because it doesn't use real money, but the same concept can be implemented in the "real" markets, although it would be more challenging (there will be occasional losses for the provider due to bad debt but it's the same with any other kind of credit, it can be managed).
In a good prediction market design users would not bet USD but instead something which appreciates over time or generates income (e.g. ETH, Gold, S&P 500 ETF, Treasury Notes, or liquid and safe USD-backed positions in some DeFi protocol).
Isn't this just changing the denominator without changing the zero- or negative-sum nature? If everyone shows up to your prediction market with 1 ETH instead of $1k, the total amount of ETH in the market won't increase, just as the total amount of USD would not have increased. Maybe "buy ETH and gamble it" has a better...
Any position that could be considered safe enough to back a market is only going to appreciate in proportion to inflation, which would just make the market zero-sum after adjusting for inflation. Something like ETH or gold wouldn't be a good solution because it's going to be massively distorted on questions that are correlated with the performance of that asset, plus there's always the possibility that they just go down, which would be the opposite of what you want.
Jun 08, 2023
20A lot of the money comes from the bad traders. If you have no bad traders, the prices are correct.
A better mechanism though is to "subsidize the market", meaning the person who wants the information incentives the market to collect it. In particular, you can set up subsidy schemes where the average cost to the subsidizer is proportional to the number of bits of information they gained.
Probably related: Zvi’s posts Prediction Markets: When Do They Work? and Subsidizing Prediction Markets
1A lot of commentary here confuses individual returns with improving information. Stocks generally have returns from business, and this is important to information-free investors. But those don't matter for info purposes. Even in the stock market, all of the information value about where to direct capital comes from those trying to BEAT the market. Those with opinions backed by money making individual relative decisions. The masses buying indices or simple spreads don't actually increase the effectiveness of capital allocation.
Prediction markets have a "market average" of 0. There is no reason to buy a prediction index fund, and no benefit to the market if someone did so.
Predictions ONLY have information value - if you can make better predictions than the average, you get paid when it resolves, and you improve the accuracy in the meantime. If you make worse predictions, you lose money. It's really that simple.
But it's easy to forget, in the comparison with stocks, that "participation" means making and standing behind predictions, not just putting money in.
But all the people putting money into stocks, provide the market makers for the people with better information to make money.
Nope, that's my point. MOST people putting money into stocks are NOT providing any information. They're just buying a fund or following general rules that don't deviate from aggregate measures or move any part of the market relative to others.
Those who are seriously attempting to BEAT the market are giving actual price signals about how their beliefs differ from the current average.
I think Yair is saying that the people putting in money randomly is what allows "beat the market" to be profitable. Isn't the return on beating the market proportional to the size of the market? In which case, if more people put money into the prediction markets suboptimally, this would be a moneymaking opportunity for professional forecasters, and you could get more/better information from the prediction markets.
At least ignoring legislation, an exchange could offer a contract with the same return as S&P 500 (for the aggregate of a pair of traders entering a Kalshi-style event contract); mechanistically, this index-tracking could be supported by just using the money put into a prediction market to buy VOO and selling when the market settles. (I think.)
I've only watched some prediction market news from the outside, so forgive my basic question, but are prediction markets supposed to bring in money besides having new entrants bring in cash?
I've often seen prediction markets compared to stock markets, but the stock market is generally positive-sum because you're investing money in profitable businesses that pay dividends. In contrast, if a prediction market begins with 1000 people with $1000 each (and no one else joins or brings in more money), can it ever have more than $1,000,000 in the market?
If the answer is "no, it doesn't generate money", isn't that a big problem for prediction markets as a long-term concept? It means everyone will be fighting over a limited pie, and there will be no reason for the average person to join the prediction market (they just stand to lose their money to the experts). Is this a problem holding back prediction markets now, and are there ideas to fix it?