Kalshi Inc.’s Chief Executive Officer Tarek Mansour got my attention when he claimed last week that prediction markets could rival stock exchanges in a few years. Of course, this does not mean that people will buy and sell stocks on Kalshi, but that prediction markets will be where information is aggregated and prices set, with the New York Stock Exchange and its ilk relegated to processing orders.
To some extent this has already happened. If you read a story on the direction of stock prices, it’s probably based on futures contracts rather than aggregating buys and sells of individual stocks. Will prediction markets exert a similar influence and become the first place traders take new information? And what would that mean for markets?
Before public trading of financial futures and options began in 1973, information flowed to stock exchanges in individual trades. These were used to compute indices such as the Dow Jones Industrial Average after the fact. But within a few decades, macro information was flowing to futures and options markets, and market makers used the result to adjust prices of individual stocks. Only stock-specific information is now processed in the stock market.
For prediction markets, the natural niche is questions with discrete outcomes, such as will the Federal Reserve cut interest rates by a quarter percentage point in December?
You can construct positions correlated to this bet using Fed funds futures on the Chicago Mercantile Exchange, but they are not identical to the simple bet. They’re designed for the convenience of institutions taking positions or hedging rather than for information traders. The purpose is to facilitate transactions rather than to create common knowledge of the wisdom of crowds. They move as much in response to supply and demand as indications of new information.
I can imagine a future in which Fed-watchers, macro economists, political insiders and other information traders make their bets on prediction markets, with the results used by futures markets to compute prices and execute transactions for hedgers and speculators. These would, in turn, set the interest rates used for real borrowing and lending and to price fixed-income securities and derivatives.
Media accounts and public discussion would revolve around the easy-to-interpret prediction market numbers rather than complicated derivations from financial transactions. But, for this to happen, prediction markets will have to up their game.
“Prediction market” is not a precisely defined entity. It exists on a continuum with traditional bookmakers at one extreme and markets for cash exchange of real securities or commodities at the other.
Suppose you think the Fed will change interest rates in December. An offshore bookmaker I found would pay $100 if you win and charge $250 if you lose — a fair bet if the probability of a change is about 71.4%. The CME was quoting a price of $96.22 on a December Fed funds future, implying a 69.5% probability of an easing if you assume that the only possible outcomes are no change or a quarter-point cut. A larger cut wins you even more money, but you make less if the cut is smaller. If the Fed raises rates, you pay money.
Kalshi offered a contract for $0.65 that pays $1 for a 0.25 percentage point cut — cheaper than the bookmaker or the CME. But it only pays for a quarter-point cut. Kalshi offers prices for other outcomes, though, which could attract information traders. It is also easier for retail traders to use, potentially allowing it to harvest the wisdom of a larger and more diverse crowd than futures markets. You can bet $0.65 on Kalshi, while the smallest futures bet requires a $515 margin and risks even larger losses (the bookmaker will take $10 bets).
The futures market has negligible trading costs for institutional investors, compared with what the bookmaker or Kalshi would cost you. Many traders have valuable information that gives them only the slightest advantage; they cannot trade profitably if the exchange builds in a significant house edge. Kalshi will have to slash costs and bid/ask spreads to rival financial markets.
Mansour hinted that the platform is working on alternative sources of revenue, which could allow fee reductions. He mentioned media tie-ins and partnerships. Financial exchanges get much of their revenue from this type of information selling.
Another necessary enhancement is allowing leverage on correlated bets. A lot of information is not about the probability of a single event, but about the relationship of the probability of one event relative to another. If you have to post 100% collateral — the full amount you could lose — on every leg of correlated bets, the capital costs could drive many information traders to more leverage-friendly financial markets.
Finally, it’s crucial for Kalshi to maintain a liquid market for trading out of positions. Futures markets assume nearly all customers will cash out before delivery and try to ensure it can be done at good prices. For now, Kalshi does not have the reliable liquidity to match futures markets. This feature is necessary to accommodate people who have short-term information they want to profit from, without risking everything on an uncertain final result.
If prediction markets started to rival traditional financial markets in aggregating information, the effect could be huge. Commodity futures contracts in the mid-19th century stimulated huge economic growth and innovation, first in the Mississippi valley region, and then throughout the globe. They were the financial engine of the second industrial revolution. Financial futures and options trading transformed the 19th-century financial system into the modern global derivatives economy. Prediction markets could bring a vast amount of information into financial prices and make them more transparent — common knowledge rather than esoteric secrets of a financial elite.
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