News that the owner of the New York Stock Exchange is buying a substantial interest in crypto-betting entity Polymarket made me think of Michael Crichton’s warning in Jurassic Park.
Swapping bits of DNA from highly evolved entities separated by millions of years leads to unpredictable results (if you only saw the movie, you missed most of the argument). But if the velociraptors don’t get loose, there are some large potential benefits of the offspring of a marriage between Intercontinental Exchange Inc.’s NYSE and Polymarket for both securities trading and betting.
Polymarket is a rational system, with efficiency, security and incentives designed into the platform. But it may still see unanticipated problems. Traditional financial markets evolved from primitive ancestors with irrational features that sometimes make it slow, error-prone, insecure and hindered by conflicts of interest. But some of these inefficiencies are put there for government to collect revenue and fight money laundering.
Moreover, betting is best suited to binary questions that are segregated from real-world activity — bets are not supposed to affect outcomes. Traditional markets are designed for securities with a continuous range of value that are closely tied to activities such as corporate profits and board elections. Financial market prices are supposed to affect economic outcomes.
These distinctions are blurring, and there’s room for cross-fertilization that builds on the strengths of each venue — an experiment the NYSE is now in prime position to begin.
It’s helpful to think about how these markets have evolved. At some point in dim prehistory, two humans made the first exchange, perhaps a spearpoint for a fur. Separately, two humans made the first bet, perhaps whoever raced back to camp faster got first crack at the roasted game. These seemed to be entirely distinct exchanges.
A trade seemed to have economic substance. Both parties needed to possess what they wanted to trade, and thought themselves better off afterwards. No interaction was required after the trade. A bet seemed zero-sum, and the transaction did not end there; it was necessary to decide the winner and arrange the payoff. Neither party needed to possess the stake she was betting at the time of the bet, only the losing party needed to acquire it at settlement.
Over time, the two activities grew more similar. Trading evolved from bilateral private transactions with innovations such as forward contracts and market fairs. Now the deal did not end with a handshake on terms. Merchants could trade things they did not yet have, with the physical exchange of goods mostly separated from the agreements on prices.
The invention of futures contracts in the mid-19th-century made financial trading even more like betting. While there was still a link to the physical exchange of goods, few trades were settled with delivery. Financial futures and options introduced in 1973 — many of them bets on things like inflation rates without even the theoretical possibility of physical delivery — were indistinguishable from bets.
Meanwhile, betting moved to multilateral forms including lotteries and commercial gambling in which customers played against the house. The invention of the point spread by University of Chicago mathematician Charles McNeil and the organized crime takeover of US sports betting funneled all the action to a centralized market, designed to equalize bets on both sides and take a fixed commission. Bookies became like stockbrokers, chasing fee income without knowing or caring about the games or companies involved.
In the 21st century, organizations such as Polymarket and BetFair conceive of bets as securities that pay $1 if a certain event happens, nothing if it does not happen. Bettors often trade these securities, hoping to profit from changing opinions rather than from predicting outcomes.
We are also getting to a point where the distinction of betting working best for binary outcomes and financial trading working best for real goods is breaking down. Polymarket’s technology can handle bets with up to 256 outcomes, and that limit could be raised. Financial markets trade plenty of binary securities, including credit default swaps, and many other securities such as bonds and options can be cast in binary terms. Securities like stocks, with continuous outcomes and changing natures (stocks can merge, split, pay dividends, offer control rights, carry tax implications, etc.) cause difficulties in both systems.
A key insight, originally made by John Maynard Keynes, but only appreciated by Fischer Black, is markets do not seek to find the correct price. Rather, in Keynes’ formulation, they’re like beauty contests in which each person tries to predict how other people will vote. Keynes, and many economists, viewed this as a defect of markets. But Black realized that it was their essence. As Xenophanes observed over 2,500 years ago, translating loosely, there is no correct price, and even if there were, it wouldn’t matter because no one would know it. Markets exist to weave a web of guesses from private information that can serve as common knowledge to coordinate human actions.
The crucial difference between the NYSE and Polymarket then is the approach to information.
Polymarket, and betting in general, rigorously segregate collecting private information from weaving it into common knowledge. Individual bettors bring private knowledge with their bets. When it’s time to settle, so-called oracles post $750 to vote on the outcome, and the money is split among the oracles that voted with the majority — a perfect Keynesian beauty contest.
In the NYSE, and financial markets in general, traders combine both private knowledge and guesses about how other traders will act — traders are both spinners of thread and weavers of cloth.
Both systems have weaknesses. Betting is liable to fixes, when bettors try to usurp oracles. Financial markets suffer from manipulation, insider trading, front-running and other ills.
Can ICE find a mixed solution that handles everything from binary outcomes unrelated to physical goods to trading real assets, while keeping information providers and oracles honest? Will it even try? That’s impossible to predict, but I do predict that a cross-fertilization between trading and betting venues is inevitable and will be much better than what we have today — and that it will change everything.
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