Prediction Markets

## Definition

Prediction markets are exchanges where participants trade contracts whose payoffs are tied to unknown future events. The price of a contract reflects the market's estimate of the probability that the event will occur. A contract trading at $0.67 implies a 67% probability.

## How They Work

| Contract Type | Example | Settles At |
|--------------|---------|-----------|
| Binary outcome | "Will Fed cut rates in July?" | $1 (yes) or $0 (no) |
| Scalar | "What will BTC price be on Dec 31?" | Actual value |
| Multi-outcome | "Which party wins 2028 election?" | $1 for winner, $0 for others |

## Price Discovery Mechanism

Prediction markets aggregate dispersed information through the same mechanism as financial markets: traders with superior information bid prices toward the correct outcome. The efficient market hypothesis applied to events, not assets.

Empirical evidence:
- Iowa Electronic Markets have outperformed polls in every US presidential election since 1988
- Polymarket outperformed FiveThirtyEight and RealClearPolitics in the 2024 election
- Corporate prediction markets (Google, Microsoft) have improved internal forecasting accuracy by 20-30%

## Regulatory Status

| Jurisdiction | Status |
|-------------|--------|
| US (CFTC regulated) | Kalshi, Interactive Brokers approved |
| US (state level) | Minnesota banned; other states pending |
| UK | Legal, regulated by Gambling Commission |
| EU | Legal, varies by member state |

## Key Risks

1. **Insider trading**: Participants with non-public information distort prices. CFTC has prosecuted multiple cases.
2. **Manipulation**: A well-funded trader can move prices to influence public perception, not just to profit.
3. **Liquidity**: Most contracts on most platforms have insufficient liquidity for institutional size.
4. **Regulatory uncertainty**: The CFTC vs states conflict creates legal risk for platforms operating nationally.

## Key Takeaways

1. Prediction market prices are generally more accurate than expert forecasts or polls
2. CFTC is asserting federal jurisdiction; states are resisting
3. Insider trading enforcement is the major regulatory development in 2026
4. The market infrastructure exists; the legal infrastructure is still being built

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