This Is the Worst Argument for Prediction Markets
Gannon Ken Van Dyke, a U.S. Special Forces soldier, was arrested Thursday for allegedly placing a bet about the capture of former Venezuelan President Nicolás Maduro on the prediction market website Polymarket. Van Dyke, who participated in the operation, reportedly put down $33,034 betting on the precise details of how the capture would happen, and walked away with more than $409,000.
Van Dyke was charged with “unlawful use of confidential government information for personal gain, theft of nonpublic government information, commodities fraud, wire fraud, and making an unlawful monetary transaction.” Apparently, this kind of blatant corruption is still illegal, at least if you’re not a high-level government official, a member of the Trump family or one of their friends, or the president himself.
But for prediction market companies, this is just the system operating as designed. Though both Polymarket and Kalshi have recently attempted to crack down on insider trading after bad press stemming from a string of flagrant insider trades, prediction markets are supposed to be a “truth machine,” to quote Polymarket CEO Shayne Coplan, because they process as much information as possible into the market price of their various bets—and what information could be more relevant than insider information?
There’s just one problem: This is a stupid idea.
The idea that financial markets process all information perfectly, and therefore are always right by definition, is an old one. It’s called the “efficient markets hypothesis,” first elaborated by economist Eugene Fama in 1970, though the basic idea goes back more than a century. The argument goes that in a deep and liquid financial market, it is impossible to beat the market on a sustained basis, because the market rapidly internalizes all new information.
Now, in a weak form, the EMH is not a crazy idea. Studies show that it is indeed quite hard even for financial professionals to beat an average sample of the S&P 500. But it’s also true that in a strong form, the EMH implies that financial crises can’t happen, because markets are essentially omniscient. That is obviously preposterous. What’s more, people can and do beat the market handily sometimes by successfully predicting major mispricing of assets, as memorably shown in The Big Short. Today, Tesla stock is very obviously not worth its price-to-earnings ratio of 317.
(There’s also the problem that if everyone comes to believe the EMH and invests in index funds, there will be nobody carrying out the buying and selling which allows markets to digest information in the first place. But I digress.)
While the EMH is a flawed theory about the stock market, it is completely ridiculous when applied to prediction markets. For one thing, a key premise of the EMH is that the financial market is deep and liquid. That is indeed the case for the S&P 500, which accounts for trillions of dollars in assets and tens of millions of trades every day. Prediction markets, by contrast, are routinely very thin. This Polymarket bet on how many times Elon Musk will tweet between April 21 and 28, for instance, has just a few million dollars’ worth of trades. Someone with an agenda—like a Musk critic attempting to publicize his grotesque Twitter/X addiction, or Musk himself looking to make a quick buck—could hugely distort the market by spending a relatively small amount of money.
Second, there is no reason to believe that most prediction market participants are investment professionals looking for a profit. These companies make the vast majority of their money on sports betting, while the vast majority of participants lose money. The people feeding information into the market “truth machine,” in other words, look a lot more like gambling addicts than scholars of politics and international relations. Garbage in, garbage out.
Third, there is the possibility that prediction markets will influence the things they purport to describe. Musk could easily rig that bet mentioned above. Someone who bets that something very particular will happen and then actually does that very particular thing is in pretty good shape to win that bet. The CEO of Coinbase recently did exactly that in an earnings call by specifically mentioning several words that were part of a prediction contract. Some dude recently won a prediction market by throwing dildos onto the court of a WNBA match (though in that case, he didn’t get his payout). Someone may have won a prediction market bet on the temperature of the Paris airport by tampering with thermometer equipment. And it’s certainly possible that Maduro would not have been captured had Mr. Van Dyke not been able to make a bet on it happening. It’s like some machine bringing the worst kind of hyper-financialized gambling directly to life.
Some combination of these factors must be why Van Dyke managed to make so much money on his Venezuela bet, along with all the other insider traders. Prediction markets are hideously inefficient, with prices wildly unreflective of reality, and are therefore a perfect tool for insiders to come in at the last minute and shear some gambling-addict sheep. In terms of the well-being of the American people, they are worse than useless.
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