Reader mailbag - prediction markets

In today's inbox:

Hello Eric,

My name is [redacted].  I read your article about prediction market regulation with interest.

As a student in 2013 I placed a single $60 bet which brought down iPredict from a run on the market related to Peter Dunne, which I intentionally caused based upon groupthink and illogical beliefs in the truthiness of the insider betting ring. I knew exactly what would happen when I joined and placed the well timed bet. I knew what I would prove, and let the energies of my opponents be redirected into their own damage.

iPredict is long gone, a decade ago, RIP. It was fun, but I guess if it had lived longer it could have competed with Kalshi and Polymarket. But now I live in the United States, and there are wildfires, and people are betting on wildfires on "prediction markets". How can you endorse this.

What is big may fall, what seems consensus may be false, and ultimately: I will be watching. I look forward to your next article about moral hazard.

My reply:

iPredict was always fun like that. Folks would convince themselves that a spike was due to an insider, and sometimes it was, but sometimes it wasn’t – whether a noob trader who placed a dollar-value order without checking the book, or someone just having a lark at low dollar stakes. But the markets proved remarkably accurate overall: trades at $0.75 turned into contracts paying out at $1 about 75% of the time. 

It’s been amazing to see what Kalshi’s been able to build in a world without deposit limits. 

The main concern I’d have on wildfire markets would be whether they’d encourage a very bad kind of insider trading. I don’t think Kalshi has any wildfire markets; their natural disaster markets are all on completely exogenous events. Polymarket has had those; best I’m aware, they’re not yet CFTC-authorised. 

I don’t know how material the risk is. I mean, a slightly less direct route would be to short insurers with exposure to that risk before starting fires. Similarly for a lot of the other ‘it will encourage them to do the bad thing’ risks: there are generally already very thick financial markets where options trading could get you similar results. I don’t think Trump needs prediction markets to cash in on Trump-induced oil price volatility. Brent crude futures are enough. 

At the same time a large punt on oil futures can have many causes, including “I will need a lot of oil in a few months”. A large and suspiciously-timed punt on a prediction market can lead to questions of who made the trade, identification of the trader (you have to do your KYC to trade at Kalshi), and then inquiries. 

I really wish Kalshi would set a market on “giant Wellington earthquake”. I could pay a friend in the US to take a position for me and treat it as insurance on otherwise uninsurable local earthquake risks. I’ve long wanted parametric insurance on a Wellington earthquake, and that is mathematically identical to a prediction market contract on it. Maybe someday!

Kalshi's Natural Disaster markets are here. You can trade on:

• How many major Atlantic hurricanes will there be this year?
• How many Atlantic hurricanes will there be this year?
• Number of tropical storms in the Atlantic this year
• How strong of an earthquake will occur worldwide before Sep 1, 2026?
• Will there be an 8 magnitude earthquake in California before 2027?
• 8.0 magnitude earthquake in Japan before 2030 [39%!]
• Number of tornadoes this month
• Major volcano eruption this year?

The California earthquake market has a 5% chance of the event, and just under $400,000 in volume. But the order book is still thin at reasonable prices. You could spend $400 and buy every contract in the book up to a $0.10 price, and get a $5100 payout if the event happens. Perhaps putting a giant buy order into the book would draw out liquidity.