I linked to Nick Whitaker and J. Zachary Mazlish’s powerful critique of existing prediction markets (“Why prediction markets aren’t popular“; see above) in one of my previous posts (see here), where I also promised that I would respond to their points, so here it goes:

I must, however, begin with a confession. Although I read Whitaker and Mazlish’s words over a month ago (their excellent piece was published on 17 May 2024), it has taken me over a month to reply in large part because their critique of prediction markets is a devastating one. For starters, they pre-empt prediction market defenders like yours truly by first exploring the legal environment of prediction markets. Although a few well-defined betting categories are illegal (e.g. assassinations, elections, etc.), Whitaker and Mazlish conclude that “prediction markets are, in large part, legal …” In other words, prediction markets have failed to attract investors not because of regulatory impediments or other “legal failures” but for other reasons.

So, what are these reasons? Here, Whitaker and Mazlish’s deliver a mortal one-two-three combination knockout punch. In summary, they first identify the three types of investors or traders that prediction markets must appeal to in order to succeed: (1) cautious or risk-averse “savers”, i.e. long-term investors; (2) thrill-seeking, risk-loving “gamblers”, i.e. dumb-money day-traders or short-term investors; and (3) “sharps” or professional investors. And then they explain in so many words why prediction markets do not appeal to any of these groups of traders:

1. Savers: For starters, prediction markets don’t appeal to “savers” because such markets are zero-sum: “Every winner of a prediction market necessitates an equal and opposite loser”. Most “savers”, by contrast, prefer low-risk portfolios that are expected to generate positive returns over long time horizons.
2. Gamblers: Next, prediction markets don’t appeal to “gamblers” because most prediction markets take too long to resolve: “for gamblers, quick resolutions are one of the key things that make a bet attractive and exciting”. In other word, “gamblers” mostly prefer quick action, i.e. bets with fast payouts, the same day they are made.
3. Sharps: Last but not least, prediction markets don’t appeal to “sharps” because of the lack of dumb-money gamblers and liquidity-providing savers. Without these first two groups of traders, sharps are left with little incentive to join the fray, or in the eloquent words of Whitaker and Mazlish:

As most prediction markets also lack many of the features that attract gamblers, whom sharps would prefer to trade against, sharps are left with the unappealing prospect of trading only with one another. This is analogous to turning up to a poker table and discovering that all of the other competitors are poker champions. You would much rather have been at a table of drunk tourists.

But what if we could somehow attract high-risk gamblers and low-risk savers? As it happens, my colleague and friend Steve Kuhn is creating a new type of information market that many gamblers — and maybe even some savers — might find attractive. Why? Because Kuhn solves most, if not all, of the problems identified by Whitaker and Mazlish! Stay tuned, I will describe Kuhn’s ingenious proposal in my next post.