On Prediction Market Regulation
(This is my comment re CFTC call for comments on prediction markets.)
As an economist, not a lawyer, I write here on public interest, not what is legal.
Like all financial markets, prediction markets can serve many functions, such as moving and cutting risk, collecting and sharing information, and the fun of action and proving yourself in competition. For decades, that risk function was the only one U.S. regulators allowed as a justification, but I’ve long argued for a huge potential info value, far more than what we now realize. I want these markets to grow toward that potential. While I personally don’t mind people having fun, I see that others mind, and we might have to compromise there.
Focusing on that info function, prediction markets have many issues in common with other info institutions, like gossip, academia, and journalism. All info institutions can induce folks to (A) reveal info better kept secret, (B) reveal secrets people promised to keep, (C) waste time and money that could be used productively, (D) make misleading contributions to get favorable treatment, (E) change the world to get favorable treatment, and (F) reward participants unequally.
I admit these are real issues, but I say we should treat the various info institutions similarly, unless we find specific reasons to treat them differently. For example, if you wouldn’t forbid govt employees from talking to reporters, for fear they’ll reveal govt secrets, also don’t forbid them from trading just due to similar fears.
On (A), an example is election-day who-wins predictions, which many say discourage voting. But as the risk of over-regulation here is severe, the first amendment should protect prediction markets as an info institution, especially markets on politics and policy. Just as protests are protected, since there are things you can say via protests you can’t say via mere words, trades should also be protected, as there are things you can say with trades you can’t say via words or protests. Putting your money where your mouth is adds punch to your words.
On (B), orgs have legit interests in keeping secrets, but outsiders often have legit interests in exposing them. Many of history’s most lauded journalism stories were enabled by org leaks. There’s a tradeoff here, and requiring everyone to work to help all orgs keep their secrets goes too far. We have strong rules on the books now re prediction market “insider trading”, but note that such rules for stocks have had limited effects. At public firms announcements, half of the price change happens beforehand, and half of that is from insider trading. We shouldn’t expect prediction market rules to succeed much better, or to result in much worse harms.
On (C), other financial markets already allow as much pure “gambling” as anyone could want, and compared to prior ages we today let people devote great time and money into non-productive fun of many sorts, including news, making risky choices of who to date, and making risky choices of careers like acting, music, or athletics.
On (D), speculative markets are actually far more resistant to manipulation than other info institutions. When traders expect more efforts to manipulate a price, they respond so that prices on average become MORE accurate. Also, in head-to-head comparisons with other info institutions, with the same question, time, participants, and resources, speculative markets have been consistently about as accurate or much more accurate.
On (E), life insurance has big enough stakes and easy enough personal influence that we reasonably regulate it to prevent murder for money. But we see almost no cases of traders successfully sabotaging firms to profit from stock trades; firms seem too hard for individuals to influence compared to the stakes. And when prediction markets have been made on events that individuals can influence, it seems traders have been well aware of this fact, and saw this fact as adding to their fun.
On (F), other info institutions also give unequal rewards for intelligence, education, effort, and good social connections. Yes, we could create amateur-only markets, but few would want to trade there; most want to try their hand competing with the best.
Due to their great info potential, let’s approve prediction markets by default, especially when they can inform topics that matter, and only restrict them when we see clear evidence of harm, applying similar standards and scrutiny as we do for other info institutions.