(2021-06-20) Torenberg A Primer On Prediction Markets

Erik Torenberg: A Primer on Prediction Markets. Last week we discussed how often elites when making predictions have neither skin-in-the-game nor accountability. ()2021-06-13-TorenbergTheTautologyOfTheElites) This week we’ll talk about a technology aiming to introduce both.

In his seminal 1945 essay, The Use of Knowledge in Society, Economist F A Hayek argued that market prices are the means by which disparate pieces of information are aggregated.

what if, instead of asking, say, Elon Musk when we’re getting self-driving cars, we could ask all Tesla employees working on them directly?

What if, more broadly, everyone had skin in the game for their opinions?

That is the hope and promise of prediction markets.

The most popular prediction markets exist in sports and politics, but effectively, futures contracts, bounties, and insurance agreements are all prediction markets in that they use people’s desire to make money to predict the future

Why are Prediction Markets important?

At the highest level, prediction markets are important because they can lead to better decision making.

prediction markets are truth-seeking machines

How could this be used in the wild?

Consider a board determining whether it should hire or fire a CEO. It could decide based on its own instincts, or it could aggregate insights from the employees. A corporation could ask, “What will our Q1 revenue be if we fire our CEO?” and conversely, “What will our Q1 revenue be if we don’t fire our CEO?” Jfc horrible example. 1Q?

More applications include the:
Likelihood of a homeland security threat
Global extent of a pandemic
Success of a drug treatment (and its massive fixed cost)
Sales revenue of an existing product
Cost of a government funded project
Effects of a trade agreement or government bailout

Over the past 20 years, these concepts have been applied more broadly to such diverse topics as business project deadlines (Project Xanadu), intelligence analysis (DARPA’s experimentation), and box office success (Hollywood Stock Exchange).

One of the most interesting applications of prediction markets popularized by Robin Hanson is Futarchy: Government run by prediction markets

In a Futarchy, governments can do the following: 1) allow citizens to democratically vote on which metrics to optimize for and 2) create markets to let the wisdom of the crowd inform how to reach those goals. Democracy tells us what we want while speculators bet on how to get it.

Under a Futarchy, there would at least be some market for truth-telling politicians

While Futarchy may provide a good theory to make decisions, at this time, it doesn't sufficiently address complex and important values like fairness and integrity and justice.

Common Criticisms

The powerful aren’t incentivized to use prediction markets:

Implementation challenges

two major factors to consider: (a) the cost of running & maintaining the markets and (b) the clarity of the markets & associated outcomes.

Prediction markets currently are more like gambling (either I win and you lose or vice versa) versus investing in most other markets (with a positive overall growth rate).

Outside of cost, the clarity of the markets and outcomes can be a major challenge. Regarding the markets themselves, we need explicit language without any possibility of misinterpretation. If the market says that Steph Curry will hit a three in tonight’s game on June 20th, 2021, what happens if the game is delayed and he doesn’t hit a three until 1am EST (the next day). If the market is for a project to be completed by a certain date, how do you define “completed”? What if everyone thinks the project is done but then needs follow up work the next month? (Claim-Refactoring Service)

And if prediction markets are run completely decentralized, how do you prove that an outcome truly occurred (i.e., the Oracle Problem)?

Causal relationships

The last major bucket of challenges is when betting performance impacts the actual results and can become self fulfilling prophecies.

On the extreme negative side, this can lead to assassination markets

Yet on the positive side, if there is a market for a certain project to be finished by a certain time, those involved could be financially motivated to ensure that it does get completed

When it comes to implementing prediction markets, we’re still in the first inning.