Brian J. Gaines is a professor of political science at the University of Illinois Urbana-Champaign and the Honorable W. Russell Arrington Professor in State Politics at the U. of I. System’s Institute of Government and Public Affairs. Gaines spoke with News Bureau business and law editor Phil Ciciora about the rise of prediction markets in the U.S. and their effect on domestic and geopolitical events.
What are prediction markets and are they new?
Futures markets are not brand-new, but prediction markets in which event-based contracts are bought and sold are enjoying explosive growth thanks to some recent court decisions. You can now legally bet on nearly anything without having to go to a casino or call a bookie. Everything can be done on a laptop or smartphone.
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How does insider trading apply to prediction markets?
If it is tricky to regulate the markets for initial public offering shares of SpaceX or future cattle contracts, how much tougher will it be to ensure fairness with trades related to NBA games, upcoming elections, potential terrorist attacks, the weather, or even Taylor Swift’s wedding day and venue?
Laws against insider trading — that is, exploiting confidential information in trading markets for personal financial gain — and market manipulation — actions taken to distort information affecting financial trades — are notoriously difficult to enforce. Evidence is usually circumstantial, and robust free-speech protection can be in tension with preventing conspiracies to spread false information or coordinate stampedes.
Most of the relevant legislation and regulatory framework is decades old; some, from the 1930s, is nearing its centennial. Technological advances have made enforcement harder, and the vast broadening of what is traded is making such problems much harder to regulate and police.
What is the history behind prediction markets and domestic politics?
In terms of domestic politics, betting on presidential elections was not strictly legal but was, just the same, a widespread open secret in the first half of the 20th century. It was eventually crowded out by other gambling options and phased out by the enforcement of existing laws.
Modern political betting dates from the late 1980s, when the University of Iowa Business School obtained an exemption to run a futures market on elections for research purposes.
Americans then trickled into overseas betting markets. Most controversies related to whether some fat cats were trying to flood the markets in order to generate good publicity for their preferred candidate or bad news for their dispreferred candidate. The claim was not that they were engaging in financial cons for profit, but that they were aiming to manipulate betting odds in the belief that these would somehow move marginal voters who like to jump on bandwagons.
What effect could prediction markets have on geopolitical affairs?
This is a more worrying area. The U.S. Department of Defense tried to launch a brief experiment in events trading to forecast and model global risks a couple decades ago, in the aftermath of 9/11. But there was significant unease with the plan, and it was dropped. Forecasting tournaments, in which participants would submit predictions for future events, somewhat took up the slack, but those were never full-fledged markets like we have now.
An obvious worry is that if someone can profit by predicting something grim like a terrorist attack, then that creates new incentives for perpetrators of those attacks. People already commit grievous crimes to make ideological points or inflict great harm on the public. Setting up another path for fanatics to finance and capitalize off crime is extremely perilous, to say the least.
On the other side, if U.S. government insiders aim to exploit classified information as a side hustle, they might inadvertently expose clandestine programs or state secrets. Those in possession of sensitive information can already choose to leak or sell it, of course, and history is rife with such examples. Alger Hiss and Julian Assange did not supplement their espionage benefits by collecting tidy prediction-based profits.
Although inference from market movements in the absence of specialized knowledge is very hard to gauge, one can imagine insiders at the companies running these markets spotting trades by customers who plausibly have specialized knowledge, and thereby gaining valuable insider information that officials would be loath to publicize.
There is a bipartisan bill co-sponsored by U.S. Reps. Nikki Budzinski, D-Ill., and Adrian Smith, R-Neb., that would do just this. Their PREDICT Act also covers family members and seems like a sensible first move. The ban on members of Congress exploiting insider knowledge of pending legislation for stock trading is of pretty recent vintage, as the STOCK Act was passed in 2012. Critics allege that it is not well enforced. But that is no reason to give up.
I do not yet see any futures-market contracts on the PREDICT Act actually passing both chambers of Congress and being signed into law. The default expectation about any bill is that it will fall victim to limited legislative time and die in committee.
Can prediction markets realistically self-regulate?
Right now, the poster boy for voluntary cooperation is an American soldier who made a few hundred thousand dollars betting on the downfall of Venezuelan President Nicolás Maduro, with the benefit of insider knowledge of Operation Absolute Resolve. He was indicted in Manhattan federal court for violating multiple federal laws, including unlawful use of confidential government information and theft of nonpublic government information. The trading platform he used cooperated extensively with the U.S. Department of Justice in his apprehension.
It would be wildly imprudent to conclude that self-regulation is flawless from one such case. In the end, the mere existence of betting markets on events prone to secrecy creates myriad problems far beyond the fairness of the gains and losses. “Caveat emptor” or “let the buyer beware” applies when putting money on something that feels more like a drinking game than an educated guess on the price of wheat next winter. And when we think of the downstream hazards of a world in which lots of money is changing hands according to events that can be shaped by some of those same hands, let us all beware.
