Hello and welcome back to TPI’s podcast, Two Think Minimum. It’s Tuesday, January 24th, 2023. I’m Tom Lenard, president emeritus and senior fellow at the Technology Policy Institute, and I’m joined by Scott Wallsten, TPI’s president and senior fellow, and senior fellow Sarah Oh Lam. Today, we’ll be talking about political prediction markets and the regulation of those markets, focusing on the popular site, PredictIt, as a project of Victoria University of Wellington, New Zealand, and Aristotle, which is the contract service provider for PredictIt. PredictIt was established to facilitate research into the way markets forecast events. PredictIt makes its data available to the academic community at no cost. I, and many other people follow PredictIt pretty closely during election seasons. And of course there are many active traders on the site, but if the Commodity Futures Trading Commission has its way, neither the traders nor the consumers of election information from the site will have it available for future elections because the CFTC has told PredictIt to close down by February 15th. To help us understand what’s going on, we are joined by John Phillips, the CEO of Aristotle, and David Mason, the firm’s general counsel. Welcome John and David.
Thank you. It’s good to be here.
So probably most people who are listening to this podcast know something about PredictIt and about political event markets, but can you briefly explain what they are and how they operate?
Sure. So PredictIt is a prediction market, as you say, it’s used for forecasting and it’s structured like a stock market where you can buy or sell shares on forecasts that you wish to make. And for every person who thinks that something’s going to happen, and the odds of that are 60%, there’s somebody on the other side who’s willing to take the other side of that at 40 cents, or 40%. And then you’ve got a contract. And that price of that contract will vary depending on news events or other things that might affect what the odds are of that event occurring or not occurring. These are $1 winner-take-all contracts, so that if you put 60 cents down that Ted Cruz would be the Republican nominee in 2024, and he turns out to be that Republican nominee, your 60 cents is worth the dollar. The person on the other side of that, who put in 40 cents that this was not gonna happen, he loses his 40 cents in that eventuality.
The nice thing about it, and the thing that makes it so engaging, is that you don’t have to wait until the general election, or more broadly, the event to occur in order to change your opinion and sell your position. So you may love Ted Cruz to be the nominee at 60 cents and you hate him at 70 cents. And so if you bought that share at 60 cents and his odds went up, miraculously in this case, to 70 cents, you’d have a 10 cent profit of which PredictIt takes 5%, I’m sorry, 10% of that. So we get a penny of that 10 cent profit. When you make that share trade, now you can go wait till he goes back down at 20 cents and buy those shares again if you think he’s undervalued, or you could take the other side of that bet. So that’s how PredictIt functions. There are about 80,000 traders with at least $1 in their account currently. And it’s a lively, entertaining, surprisingly incredibly accurate–not perfect, but very accurate–barometer or forecast mechanism on all kinds of political event questions. I’ll stop there and see if you have any questions for me.
Well, let’s get into what kinda the- what’s going on currently as a background, how long has PredictIt been operating?
So we received what’s called a no-action letter or no-action relief from the Commodities Future Trading Commission to open up PredictIt with Victoria University in October of 2014, right before the election. So it’s been over eight years that we’ve been operating.
What did you all do wrong that has prompted the CFTC’s action?
Well, you have to ask the CFTC that, and I can guarantee you won’t get an answer. That’s part of the dilemma, and that’s part of the reason why traders, educators who are using the PredictIt data and Aristotle are suing the CFTC and asking for an injunction.
So are political prediction markets or event markets more generally legal or illegal in the United States?
I’ll pitch that over to you, Dave.
Sure. So certain event markets are permitted by the CFTC and so for instance, you can buy weather features, right? If you wanna predict how many hurricanes are gonna make landfall in Florida and the hurricane season you can do that and you can, that would have obvious hedging implications or possibilities for insurance companies or other people like that. By statute, you can’t have a prediction market on war, terrorism, assassination–those things, for understandable reasons. And by a CFTC decision known as the Nadex decision, the CFTC said that regulated commodities exchanges may not offer contracts on elections. And that’s why PredictIt, Victoria, and Aristotle had called no-action or relief or an exception to the general rule to be allowed to offer these markets in the United States. So that decision, by the way, about election markets is under review right now. Another licensed exchange has asked the CFTC to reconsider that decision. They initially said they were gonna make that decision by October in time for the election. They didn’t do that, then they said January, they didn’t make that deadline. They’ve now extended it to March.
So they- I mean, you know, looking at it from the outside, they seem to have a bias against this type of market. Is that, do you think that’s accurate? I mean-
Well they’re certainly reluctant to engage in it. Part of it is, I think they just don’t understand very well how the markets function and what the public purpose is. Because you know, in a, in a typical financial market, the primary purpose is to help the parties to the exchange. And of course there’s nothing wrong with that, lots of good about it. But when we’re setting the price of oil futures or pork bellies or whatever, it’s not for the general public, it’s for the people who use or make those commodities. And in the case of a political prediction market, the information that’s generated is a benefit to the general public. And I think the regulators with their typical blinders on about what- how the world works and what they regulate, just have trouble seeing that there’s this great public benefit in these markets that should compel them or make a compelling case to allow.
So, I mean, you’re implicitly saying that they think that there is some harm, but John, you said if you ask them, they won’t tell you what their reasoning was. They must say something. I mean, what have they said, publicly or even privately? If you can, anything you can, you can report, anything you can say, I mean, have said anything at all?
I can’t say as to political prediction markets in general. They have raised concerns about manipulation blockings. And in the case of PredictIt, that’s hard to imagine. We have an $850 position limit, and with the amount of money sloshing around elections right now, $850 isn’t gonna buy you anything. We also have a 5,000 trader limit in one contract. So if that were their fear, they cited state anti-gaming laws. A lot of states make it illegal to bet on elections, though that really hasn’t stopped them in other areas. So that, that’s in general. In particular as to PredictIt. They issued a letter in August of last year that simply said that the market had not been operated in- within the terms of the no-action letter. And they reiterated about 10 or 11 different terms, that $850 position I mentioned, and some other things. And so you really have to look at the letter and, and it doesn’t say specifically what we did wrong.
In their mind, according to them, all that matters is that you violated- they believe you violated a rule, not that it actually hurt anybody. All they care about is the rules that they made, they say you didn’t follow some of ’em, and therefore you have to be shut down, forget whether it helped or hurt people. Doesn’t matter. They don’t care. Right? Is that being too harsh?
Yeah, no. And they don’t have to tell us what it is that we did wrong. That’s the other piece of this.
Right. Which, which one, which one of those conditions, you violated.
Right. That’s right. And that gets to sort of the heart of the litigation, I think, and what the implications are, which is why I’m so pleased to have Dave on today because this is not the only federal government agency or government agency that probably behaves in this fashion. And that gets to what happens if, you know, we win this injunction. Right.
So you’ve gone to court to get kinda- a stay on this, on this order to, to close down. Right? If you could explain the status of all of that.
So we, we’ve actually challenged the entire action, the entire shutdown of the market. And we’ve done that on the basis of the Administrative Procedures Act. And of course there are, as John mentioned, all kinds of federal agencies that regulate Americans’ lives in various ways. And basically the Administrative Procedures Act says, well, if you’re gonna do that, then when you make these decisions, you have to provide a reason, explanation for what you’re doing. And the courts are able to review that. Right? And so if, if some agency cuts off somebody’s business, their ability to make a living or whatever, they have to give reasons and the court has to be able to review. So, and the CFTC doesn’t have any exemption from the Administrative Procedure Act, right? They do not. But they have said that these no-action letters are not reviewable by courts and they don’t have to provide reasons.
And they’ve said that for a technical reason known as the Final Agency Action Doctrine. And so that’s what we’re fighting over in court, is basically whether a federal agency can take this sort of action without review by the courts and without giving specific reasons for what they’ve done. And the first stage of that is to try to, to get what’s known as a preliminary injunction to allow us to keep operating the market while the court hears the broader case. And that motion for preliminary injunction is gonna be heard by the Fifth Circuit, which sits in New Orleans on February 8th.
Have there been other cases on the same issue? Because you’d imagine that other agencies have tried this same thing and has upset somebody.
So there actually have only been a few cases on the specific topic of these no-action letters. And no-action letters are issued by a variety of different agencies that–the Communications Commission, the Trade Commission, the Securities Exchange Commission–in, in addition to the CFTC. But each agency’s version of those letters is a little bit different. So the few cases that have been out there have been different enough from ours that we believe the facts meant for a new outcome. There was one case in the DC Circuit for anybody with legal interest who wants to look it up- the Soundboard decision, which the DC circuit said was not “final agency action.” In that case, because the group that had asked for the relief had the option of appealing to the commission, rather than just getting relief from the staff. We didn’t have that option in our case. That’s why we think that’s different. In another case, the group was challenging, sort of indirectly, it was challenging an action that some schools had taken in reaction to a Department of Education letter. And, and the court said, look, the schools had a lot of choices in how they complied with this. And so you can’t come in and, and challenge this as a, as a non-party, but really very few cases. And so this is likely to break some new ground one way or another.
A little bit about the CFTC’s authority in this case. Does Congress need to speak or what do you think of the CFTC Act?
Well, we think the CFTC has acted unjustly and abruptly. And so yes, should Congress act, that would be wonderful, but the agenda in Congress is full. And the one thing we know is they’re not gonna intervene in the middle of a lawsuit. So we’re gonna win or lose this lawsuit. But perhaps, depending on what happens, Congress could follow up with legislation, yes.
It seems if you, if you don’t get an injunction, then even before the case is heard on its merits, the markets will disappear, basically.
It would be impossible for us to continue to operate the market without an injunction, that’s correct. Because if we’re held, in terrorem, in essence, the, the threat is that if we continue to operate the market, they’re gonna come in with an enforcement case and, and bring the hammer down.
Right, right. And let’s say that you do get the injunction. How, how long would it be until the case was heard on its merits?
Well, the courts don’t operate on mandatory schedules, so it would be months at a minimum and probably months beyond that to get an opinion. And whichever side were to win or lose, then you’ve got the possibility of an appeal.
So not to be glib, but is this one above, is this the contract you could buy on PredictIt? <laughs>
Not on PredictIt, but there actually is another market out there that will allow you to buy a contract on whether we’re gonna get a preliminary injunction or not.
What are the odds according to that?
You know, I, I have not looked to see- it’s not a retail market, so you have to be a, you know, an organization with certain, you know, cash and so on like that to do it. I haven’t looked to see what the odds are.
Alright. But even if you got an injunction, would that just mean that the current contracts would continue or would you be able to-
Right. It would, it would allow us to continue to have the current contracts be offered until the case was concluded. And that’s sort of a normal- it’s to hold things where they are, because obviously if the market closes down, then the case is, is gonna be practically moot if not legally moot by the time the, the court gets around to issuing a decision.
But it wouldn’t allow for any new contracts to be introduced until-
We’ve asked. So we have these markets involving the 2024 Republican and Democratic presidential nominations general election, and we’ve asked to be able to keep those open and to add new candidates, right? If they come up. But so very, very limited in that respect. And of course if we win the whole thing then, then we would hope to be back in operation and offering Senate and House races and, and other political questions as we, as we have in the past.
Right, right. We know we often, I mean at any one time we might have 300 different markets were it not for, for this. Right. New Hampshire’s primary, you know, all those things that are- people wanna, wanna forecast.
So in terms of the slightly broader landscape, as you know, the University of Iowa has been operating political prediction markets- I don’t think as many markets as you all have had, but also kind of a, as an academic institution, I guess also under a no-action letter. But have they, have they been told to cease operations?
Not that I’m aware of. They were really the trailblazer on this. It was 30 years ago that they got their no-action letter and the no-action letter that Victoria University received that I referenced at the beginning of this program, it was patterned on University of Iowa’s the no-action letter they received.
Yeah. So I guess since they didn’t tell you which one of the conditions you violated or the no-action letter, you don’t, you can’t really explain why they went after you and not the University of Iowa.
I can’t <laugh> I can’t explain anything.
Maybe that’s the university, the University of Iowa has two senators and put several members of Congress <laugh> that-
New Zealand does not. That’s a good point. <Laugh>.
And also, there’s another, I think a bigger operation Kalshi, which is- you referenced earlier, which has an approved, basically is an approved exchange platform from- by the CFTC and has made this application to introduce these political event markets and is waiting, I guess waiting for the CFTC’s decision. I guess I assume that the CFTC maybe <laugh>, maybe they, they’re hoping they’ll win the case against you before they have to make a decision about Kalshi or, I don’t know if you wanna speculate.
It’s hard to understand how those two are related. I can’t tell you that one of the commissioners, commissioners released a statement when the Kalshi petition was first filed, essentially saying, “Hey, it’s not fair that PredictIt should be able to do this and Kalshi shouldn’t.” And that, you know, I can understand that argument, but she at least made that connection. But other than that, the process is opaque to us. We, we did file comments on the Kalshi petition and we urged the commission to approve it and we would love to see these markets approved for fully regulated markets, designated contract markets as they’re known in technically, and in fact, we have an application to run a DCM from Aristotle pending right now. It’s moving along through the regulatory process in the CFTC.
Right. But even if we were approved, we would not–neither we nor Kalsh–would be able to offer these election contract markets because of the Nadex decision and the reasoning behind that, that Dave described. So-
What these markets is- if it weren’t for having to get these no-action letters and the CFTC, would we see other organizations, institutions and companies offering these kinds of prediction markets, do you think?
You know, to compete with you?
Yeah, we should. I mean, that’s the correct answer. Not to shut down the one. If you’re the chairman of the CFTC and you’re complaining about the pressure you’re getting, the correct answer is not to shut down the political prediction market that exists. It’s just, it’s to allow political prediction markets. This is what the voters, you know, people want.
So Kalshi is not going the route you went. Kalshi trying to get their contracts approved under the normal way the CFTC approves contracts.
So yeah. So I don’t know if you had any, any comments on this general- I mean, I, I saw the, the types of questions the CFTC was was asking of Kalshi, you know, basically it’s kind of a little bit, it’s a pre-approval process in some sense comparable to, to the FDA <laugh>, I mean, FDA’s FDA’s stuff is more life and death, but you have to prove there’s an economic purpose. You have to prove that- all sorts of things. I mean actually when I looked at those questions, I thought actually the answer to most of them was yes. That there was- could be a legitimate hedging function. There could even, aside from the fact just the information function, but I mean, what is your view on, you know, there’s lots of products that get in introduced and you don’t know exactly what, how valuable or what their purpose is gonna be ex ante, but what they turn out to have to be very useful for a variety of things.
I mean, should it be the business of a government agency to require that type of proof? Before the fact, rather than somehow showing that there would be some harm?
That’s a big question. And philosophically, I’m with the premise of your question that Americans should be able to do pretty much what they want unless they’re hurting somebody else. And we don’t see how these markets hurt anyone. But that’s so far from where we are right now, that we sort of can’t get there from here, at least in one step, right? And so our choice is, you know, as an operator interested in the space, are to go in and get no-action letter or to get licensed under the normal process. Would we love for this to be opened up more generally? Certainly.
Do you see any parallels with the sports betting process? So we’ve watched that a little bit. So five years ago it was kind of looked down upon and then you see now it’s mainstreamed. How does it compare political markets with sports markets?
Well, certainly in the sense that PredictIt has provided a market, as for do people want these markets? And the is resounding yes. We’ve had to shut off markets because too many people wanted to get into them. And so in terms of at least a public demand, that’s certainly out there. I’ll leave it at that.
Actually, do you think that the people talking about this as betting markets make- makes life more difficult for you all for one thing? You know, there people have this on one hand, aversion to gambling or gaming. On the other hand, of course everyone loves it. That’s why Las Vegas is so popular. But they’re also powerful interests in gaming who don’t want anyone else to be in their market, even though this isn’t gambling. Do you think that kind of confusion between gambling and markets makes life more difficult for you?
It does. And to take it in the, you know, in the other way, there are all kinds of people on Wall Street with big investment houses and so on like that who refer to taking investment positions as making a bet. And so, you know, it can kinda work both ways. But again, the, the big difference that we see between these election markets and gaming is the one that I, I referred to before, which is there’s public purpose to these markets, right? It’s great fun, but if you went at roulette or blackjack or whatever, there’s no public benefit. But if we’re allowed to operate this political prediction market, there’s a clear public benefit. And we think that’s an important distinction that makes this a lot different than gaming no matter how, how other-
Yeah. You know, as, as Tom pointed out in the introduction, that there are more than a hundred educators, academics, researchers at universities in the United States, around the world who have signed contracts. They get the data for free, of course, but they use the anonymized trading data to try to understand a number of different things. Why are markets so accurate? Not just political forecast markets, but all types of markets at forecasting what the future might be. So not perfect of course, but those are the kinds of, you know, what makes a super forecaster, how does that person come up with forecasts that are more accurate than the rest of the herd? And so it’s fascinating what this folks are researching and it’s important research and it, and then you’ve got, as Dave was pointing out, you’ve got the public benefit with the, the ability to double check polling results or pundits. These markets are notoriously more accurate than pollsters and pundits when it comes to forecasting election outcomes. And then you’ve got the benefit-
Yeah, to build on that for a second, sorry, sorry to interrupt. But you know this, I don’t mean to sound too conspiracy minded, but it would seem like you also would have a lot of enemies. I mean, Gallup shouldn’t like you to be there. All of these political consulting firms who do lots of polls for their clients who spend tons of money on them, they must hate this too. It sounds like, I mean, you probably don’t have a lot of political support.
Oh, I don’t know. You know what, it’s interesting. Everybody, if you like, the odds you like PredictIt if they don’t like the odds that the market’s giving you, you may not like PredictIt that day. The fact of the matter is these markets are, you know, they’ve got some real advantages to polling. One of the disadvantages are not confidential. So if you’re running a campaign and you, you wanna, you do a poll and you find out that your, your candidate has some deficiencies, you’re not gonna go out and put that up on a website. With, you know, PredictIt, it’s, it’s all out there.
So you don’t think they see you as competition?
I think some do, but you know, we’ve been doing this now for, as said, for eight years, and candidates are thrilled to tout their predicted odds when it helps them raise money or show momentum or whatever it may be. And that’s at the presidential level all the way down. So I don’t think this, you know, the pushback is coming from the talking class. I think it’s, it’s more has to do- I think we are right smack dab in the middle of one of the important fights over how broad bureaucracies’ reach should be into the lives of, of individual Americans.
Is this the first time the CFTC has come after PredictIt since they gave the no action letter?
The only time, yeah.
All, yeah, no, no, we have enjoyed a, I think a really good relationship with the CFTC over the years. And there’s been lots of communication, not once, not once have they, this is unusual, I’ll put it that way.
So we’re, and this is going back, this is going back into the- I thought I was gonna ask, this is going back to the opaqueness, but why now? What triggered it? I mean, I guess the answer is who knows, but-
Well, I know somebody who knows, you know, I just don’t know.
So I agree that PredictIt in these- they’re good theoretical reasons why they might be more accurate than polls. And I guess, I mean it’s, I don’t know. You can’t, it’s hard to make rigorous comparisons, but they do seem largely to be, they seem often to be more accurate, but not this last election, I think. Right?
Right. Yeah. So I have, I have a theory on that that I would love for somebody to study. And that is in PredictIt in other prediction markets, there’s a, there’s a support bias and that is all of the things being equal, people are more likely to wanna buy favor of the candidate they support than against some other candidate. And initially when we were running, PredictIt as a result of that, when we had a multi candidate market, right? 8 or 10 people who were legitimately contenders for the Republican presidential nomination, we could get aggregate odds. It would run up to 120-130%. And so that told us the market wasn’t functioning properly, right? Because the market really ought to be right there at or around hundred percent. And so we developed a mechanism to make it more attractive for professional investors to come in and buy the notes, right?
Because if you look at that market at 130% and you bought no on everybody, you were guaranteed to make a profit. And so we developed a margining system that made it easy for people to come in and do that and did exactly what we thought. It brought those odds back down to where they’re around hundred percent. And my theory, this is only a theory, is that a lot of those professional investors left the market after the CFTC made its announcement in August because they didn’t know what was going on and, and they were not there really for the, the political thrill of it. They were there to try and make some money and when they left the market, it left an oversupply, if you will, of enthusiasts. And those enthusiasts bid up the prices, generally speaking of Republican candidates this last fall. And I think somebody who’s interested in a great research project, we’ll make the data available to ’em and, and see if that hypothesis plays out or not. But I believe that’s what happened.
Because there would be, would be a risk I guess of, regardless if you, you were right or wrong, just losing your money because the, because the company would- they wouldn’t be able to to make good on-
Right. Unstable, unstable regulatory environment. Exactly.
Right, right. It’s an interesting hypothesis. I can see Scott thinking about how to, how to, how to test it.
I, I am, but we’ll leave it to some ambitious political science student, I believe.
Well this has been very, very interesting. I appreciate you guys coming on. Is there anything else we should know before we end this?
Well, Tom, let me just say one thing we haven’t talked about, which is the personal benefit. I know this has worked with many friends of mine. I’m not allowed to bet on PredictIt, but I can tell you for a fact when, when you have a little bit of, does this effect- that when you have a little bit of skin in the game, just a couple bucks, it clears your thinking in terms of what you think is gonna happen rather than what you want to have happen. And that’s a great thing because it also forces you to- it inclines you to absorb more information. And there’s an analogy that Sarah made about sports betting. In sports betting, the studies have shown if you put a little money into a sporting event, you consume a lot more of ESPN statistics cause you have a hunger for objective data that might help you make a few bucks.
The same I think happens with PredictIt. If you have a little skin in the game, you’re more likely to pay attention and to view with a skeptical eye the information that’s coming at you about the candidates or the election. And so if you think of PredictIt as sort of an antidote to fake news, if you bet based on fake news, you’re gonna lose your money. And so you’re more likely, with just a little bit of skin in the game to be a more careful consumer of political information, which there’s certainly another benefit there to allowing the PredictIt experiment to continue.
Yeah, no, I agree. Of course the causality probably goes both ways. Yeah. If you are a careful consumer with political news, you may be more likely to bet on- to, to participate in PredictIt.
That’s a great compliment to the 80,000 predicted traders out there. Thank you.
Right. Well thank you very much for participating in this podcast. It was very interesting. I, I think it’s an interesting and also an important- an important issue. So thank you very much.