<aside> đĄ Overview
Imagine a town square where citizens gather to reveal their opinions and predictions about future events, from policy preferences on battling a global pandemic to election outcomes. This town square is unique in that every citizen placing a vote backs it with money. Much like traditional stock markets, people use their individual opinions, knowledge, analysis, and even their biases to make a calculated vote among the choices presented. As more and more people participate in these âopinion-markets,â they become a living, breathing entity reflecting the pulse of collective belief. Thus, prediction markets are platforms powering a collective pursuit of truth, harnessing the wisdom of crowds to forecast future occurrences. They offer a fascinating window into how communities view the likelihood of future events, providing a dynamic snapshot of real-time sentiment. This interplay between prediction and perception makes prediction markets a thrilling arena for exploring the wisdom of the crowd.
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Prediction markets have two good qualities: in ideal situations, they are accurate and canonical.
Why accurate? Over the long run, prediction markets are at least as accurate as any other source of information.
How canonical?
Prediction markets short-circuit discussion of âwhich expert should we trust?â or âhow do we know which sources are biased?â All prediction markets speak with a single unified voice, that voice will always be at least as trustworthy as any individual expert, and it cannot be biased. If youâre not sure which of many competing experts (or supposed experts) to trust, you should always trust a prediction market instead of any of them.
Remarkably, in every known head-to-head field comparison between speculative markets and other forward-looking institutions, the speculative markets have been at least as accurate. More often than not, they prevail. Orange juice futures improve on National Weather Service forecasts (Roll 1984), horse race markets beat horse race experts (Figlewski 1979), Oscar markets beat columnist forecasts (Pennock, Giles, and Nielsen 2001), gas demand markets beat gas demand experts (Spencer 2004), stock markets beat the official NASA panel at identifying the company responsible for the Challenger accident (Maloney and Mulherin 2003), election markets beat national opinion polls (Berg, Nelson, and Rietz 2003), and corporate sales markets beat official corporate forecasts (Chen and Plott 2002).
They either work or you can get rich quick. Suppose prediction markets disagreed. For example, suppose the RNC ran an Official Republican Prediction Market that said there was only a 10% chance Democrats would win the next election, and a 90% chance Republicans would. And suppose the DNC ran an Official Democrat Prediction Market that made the opposite prediction: 90% chance Democrats, 10% chance Republicans. Then you could buy a share of âDemocrats will winâ from the Republican market for 10 cents, plus a share of âRepublicans will winâ from the Democrat market for 10 cents, and be guaranteed to make $1 when one party or the other wins. You have turned 20 cents into a guaranteed $1. Repeat until you are rich or the mispricing has been corrected.
This is just what financial experts call âarbitrageâ. You may notice that in finance, people always give specific prices for things like shares of stock, barrels of oil, or Bitcoins. People say things like âGoogle stock is up to $300â, but never âGoogle stock is up to $300 on the NYSE, but down to $200 on NASDAQâ. If that was true, people would buy it on NASDAQ, sell it on NYSE, make $100 in free money, and get rich quick.
In ideal situations, arbitrage forces everybody everywhere to agree on the same price for a financial instrument. Prediction markets turn claims about truth into financial instruments in a way which forces everybody everywhere to agree on how likely the claim is to be true.
Either a prediction market is not currently mispriced because of a manipulation attempt, or you can get rich quick. Hereâs why:
Suppose a prediction market was currently mispriced because of a manipulation attempt. For example, suppose there is a prediction market for whether the sun will rise tomorrow. The true probability is obviously 100%, corresponding to a cost of $1.00. But suppose some special interest who wanted to trick people into believing the sun would not rise successfully spent money to bid the market down to only 10%.
This means that you can buy, for $0.10, a share which pays $1 if the sun rises tomorrow. In other words, you can dectuple your money for free. Repeat until you are rich or the mispricing has been corrected.
Either a prediction market is not currently mispriced because of bias, or you can get rich quick. Hereâs why:
Suppose all smart people, including you, know that there is an 80% chance that the Democratsâ economic plan will create new jobs. But suppose that Republicans, because of their partisan biases, refuse to believe it, and say there is only a 40% chance. And suppose the Republicans set up their own prediction market where they bid the price of a share down to $0.40. You can, of course, go on this prediction market, buy shares for $0.40, and double your money in expectation. Repeat until you are rich or the mispricing has been corrected.
Gambling is bad, and addictive. Even still, most countries allow various forms of gambling that arenât too addictive and have some social value. For example, one could argue that investing in stocks, or investing in commodities futures is gambling in the same way prediction markets are. In that way, prediction markets are closer to stock markets than traditional casinos.
People who want to gamble can already buy cryptocurrencies, or trade stocks or place online sports bets. All these things seem more addictive than, and have less social utility than, prediction markets. Promoting or legalizing prediction markets is not going to make the gambling situation much worse than it is already - so given how useful they are, they would be a net positive.