It's traditionally been understood that

financial markets exist to allocate

capital to its most productive uses.

Recently, however, the definition of a

productive use has been expanded to

include betting on whether a regaton

artist will wear a dress to a football

match. In the past, if you had wanted to

place a bet on Bad Bunny's wardrobe

choices or perhaps the precise timing of

an Iranian missile strike, you had to

find a man who conducted his business

behind a local pub. Today, the process

is a bit smoother. Through a rather

impressive piece of legal rebranding,

what the authorities used to call

gambling is now referred to as trading

event contracts. This means that when

you inevitably lose your money on these

platforms, you're no longer a degenerate

gambler. You're a retail liquidity

provider contributing to a truth

machine, which sounds much more

respectable. I wouldn't necessarily put

it on your CV, though. Reading up on

prediction markets is somewhat

exhausting. Unfortunately, we seem to be

determined to financialize every single

aspect of human existence. It used to be

that if you wanted to know if it might

rain tomorrow, you'd just look out the

window, but now it seems you have to

check the bid ask spread on a

precipitation swap. The advocates for

platforms like Cali and Poly Market

argue that they're providing a vital

public good. The theory is that by

allowing people to bet on anything from

congressional control to the next

Federal Reserve decision, the

information fed back will be far more

accurate than traditional polling, which

is a lovely idea. But looking closely at

how these markets actually work, it

appears that we haven't so much invented

a truth machine as put a glossy user

interface on a 1920s bedding shop. and

to make it even better, invited a group

of quantitative algorithms to come in

and extract money from the public.

Today, we're going to look at how these

markets actually work, the legal

absurdity surrounding them, why the

commodities regulator is suddenly

interested in elections, and whether any

of this makes the world a better place,

or if we've just turned the whole world

into a casino. To understand why the US

government is fighting with itself over

who gets to regulate a bet on a football

game, we need to go back to the origins

of American financial regulation and

specifically onions. In the United

States, there's a federal agency called

the Commodity Futures Trading Commission

or the CFTC. They were originally

established to oversee futures contracts

on things like wheat and cotton. The

idea was that these markets would allow

farmers and factory owners to hedge

their price risks while making sure that

these contracts weren't just illegal

gambling. For a long time, the CFTC

applied what it called an economic

purpose test. They only approved

contracts that served some hedging or

price discovery function. But over the

years, the exchanges realized that they

could generate significantly more

revenue by listing futures on interest

rates and stock indices. The CFTC went

along with this and the definition of a

commodity future was slowly expanded to

include things that are not really

commodities at all. A few years ago,

Bitcoin was even classified as a

commodity. while it's about as far from

being a basic raw material, agricultural

product, or physical asset as anything

could be. So, almost anything can be

considered a commodity with one notable

exception. Thanks to the 1958 Onion

Futures Act, you can trade futures on

almost anything in America, but it's

illegal to trade futures on onions. This

happened because in the 1950s, two

traders managed to corner the Chicago

onion market, artificially inflating the

price before crashing it entirely. The

chaos led to angry farmers and naturally

an act of Congress. So to summarize the

current state of American financial law,

you can legally bet on the outcome of a

geopolitical conflict. You can bet on

the future price of an internet meme

token. And thanks to platforms like

Kalshi, you can now bet on who will

control the United States Congress. But

if you attempt to hedge your exposure to

French onion soup, or really any onion

soup, the federal government will step

in to protect the public from you.

>> No soup for you.

>> Now, regulators used to frown on

gambling, but things have changed. But

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10% off. Now, up until recently, the

CFTC has been quite skeptical of what

they call event contracts. They

explicitly banned contracts involving

war, terrorism, assassination, and

gaming. They also tried to ban election

contracts, arguing quite sensibly that

approving them would effectively turn

the commodities regulator into an

election cop. And this is not an

unreasonable concern. If you allow

people to trade contracts on election

outcomes, the CFTC is then responsible

for making sure no one is manipulating

those outcomes, which means that they

now would have to worry about whether an

election has been rigged or if foreign

governments are getting involved. The

CFTC was set up to make sure that wheat

prices are fair. Election monitoring may

be even further outside their mandate

than Bitcoin. One way or another, the

prediction market platforms decided to

push back. They took the regulator to

court, arguing that predicting an

election is not gaming. And somewhat

surprisingly, a federal judge agreed

with them. Having established the right

to offer election contracts, the

prediction market platforms naturally

decided to push their luck. Their logic

is fairly straightforward. If a

presidential election is just an event,

then a football game is surely also just

an event, too. So, earlier this year,

Kalshi began self-certifying sports

contracts. They started offering bets on

the Super Bowl, the NBA, and the

Masters. I say bets, but Kali would

obviously prefer if I said event

contracts. The distinction is important

to them, if not to anyone else.

This came as something of a surprise to

the individual American states. Since

the Supreme Court struck down the

federal ban on sports betting in 2018,

nearly 40 states have spent a great deal

of time and money setting up highly

regulated, heavily taxed sports betting

regimes. They have set up state gambling

licenses, compliance departments, tax

collection, the whole thing. No sooner

was that done when these tech companies

turned up offering what appears to be

functionally identical bets, but they're

claiming that they're completely exempt

from state gambling laws and state taxes

because their bets are technically

federal commodity swaps. If you are a

state gaming regulator who has spent the

last six years building out a licensing

framework, you might find this argument

somewhat frustrating.

A number of states have responded by

sending seize and desist letters.

Arizona has gone a step further and

simply filed criminal charges against

Kalshi for operating an illegal gambling

business, which is a bit of a step up

from a cease desist letter. Ohio has

taken an even more creative approach. A

company there is suing Kashi using the

statute of an. This is a British law

from 1710 passed during the reign of

Queen Anne, which allows third parties

to sue to recover other people's

gambling losses. The theory is that if

Kelshi is operating an illegal sports

book in Ohio, any enterprising person

can sue them to get the losing betters

money back. It's the sort of 18th

century legal instrument that you would

expect to find in a museum and not in an

active federal lawsuit against a Y

Combinator startup. But this is where we

are now. You might expect the Federal

Commodities Regulator to step in at this

point and clarify that a bet on the New

York Knicks is not in fact a vital

financial derivative. But they have not.

According to the Financial Times, the

CFTC has mostly just been avoiding the

question. Well, it's actually a bit

worse than that. Under the new

administration, the CFTC and the

Department of Justice have gone to

federal court to block the state of

Arizona from enforcing its gambling laws

against Koshi. So, the federal

government now appears to be deploying

its legal resources to defend a tech

platform's right to operate what Arizona

considers an unlicensed sports book,

overriding state law in the process.

Whatever your views may be on prediction

markets, you have to agree that this is

a rather unusual use of the Department

of Justice's time.

Now, if you're wondering why the new

administration might be so accommodating

to these prediction platforms, there's

one small detail that's probably worth

mentioning. A fellow named Donald Trump

Jr., who seems to be some sort of

relative of the sitting president, is

currently serving as a strategic adviser

to both Kalshi and Poly Market. I looked

up this fellow's background and he

appears to have no real work experience

in either strategy or advice. He seems

to be a reality TV star who also worked

for his dad's real estate company. I

can't think of why they hired him, but I

suppose it's still worth noting that the

president's son advises the companies

that the federal government is currently

shielding from state prosecutors. I'm

sure that it's it's all a coincidence.

Anyhow, if you ask the executives at

these firms why they deserve special

treatment from regulators, they won't

talk about the strategic advice they've

received. They'll instead talk about the

truth machine. The core argument in

favor of prediction markets is that they

provide more accurate information than

traditional polling or expert analysis

does. The idea is that when people have

to back their opinions with their own

money, they strip away their biases.

They bet on what they think will happen,

not what they hope will happen. The idea

is that the market absorbs all available

information and price is an objective

probability of an event occurring. It's

the efficient markets hypothesis applied

to everything, not just stock prices,

but elections, wars, weather, and

apparently bad bunny's wardrobe. Now,

this might sound great in a university

lecture hall, but the problem is what

happens when these ideas meet reality?

Because prediction markets are often

quite small and thinly traded, it

doesn't take too much money to move the

odds. And if the media is treating those

odds as objective truth, then buying the

odds might be a really efficient way of

buying positive press coverage. This has

happened already. During the 2012 US

presidential election, a single trader

lost around $7 million systematically

buying contracts on Mitt Romney to

artificially inflate his chances on a

platform called Inrade. The goal wasn't

to win the bet. The goal was to make the

race look closer than it actually was

and to keep voter enthusiasm high. $7

million is a lot of money to spend on

something that isn't a bet, but as a

media strategy, it's not bad. Cable news

covered in trades odds constantly.

More recently, in 2021, a YouTuber named

Brian Rose ran for mayor of London.

During the campaign, he was accused of

gaming the odds on the betting exchange

markets by allegedly having people place

bets on his unlikely victory. He could

then point to those betting markets as

evidence that he was a serious candidate

with real momentum, which journalists

then reported. So, if a wealthy

individual or a political campaign can

spend a few million dollars to move the

odds on a thinly traded prediction

market and then point to those odds as

evidence of public support, you haven't

really built a truth machine. You've

built a PR tool, but one that comes with

a chart. So, if prediction markets are

not entirely reliable as truth machines,

what are they actually for? To

understand the current boom, it helps to

look at the broader shift in retail

investing over the last few years.

Dimmitri Cafenus of the Hidden Forces

podcast uses the term financial nihilism

to describe what's been going on. The

idea is the traditional paths to

building wealth feel increasingly out of

reach for a lot of young people. So

instead of saving and investing

carefully, they try to get rich quickly

by putting money into crypto tokens

featuring pictures of dogs that were

pitched to them by edgy billionaires or

buying shares in bankrupt companies.

Prediction markets slot in perfectly

here. If you go back 5 years, crypto was

the exciting product that everyone was

talking about. But crypto is kind of

dull today. Bitcoin is up about 25% over

five years, which sounds okay until you

realize that a money market fund paying

4% with no risk at all would have gotten

you most of the way there. Your dad has

achieved triple the return of Bitcoin

over the last 5 years with his index

fund. And he didn't have to check his

phone at 3:00 in the morning or pretend

to understand what a layer 2 rollup is.

Michael Sailor is desperately trying to

make crypto seem exciting again by

structuring leveraged payouts that could

give you a return of 10% or wipe you out

entirely, which might not be the kind of

excitement most people need. At least

with prediction markets, you can watch

the sports you've bet on and have

something exciting to talk about, like

the fact that someone just bet $100,000

that the US government will announce the

existence of aliens at some point this

year. The problem with all of this is

that whenever a large pool of

enthusiastic retail money shows up

somewhere, the professionals are usually

not far behind. According to the

Financial Times, large quantitative

trading firms like Susahana and DORW,

firms that normally act as market makers

on stock exchanges, are now setting up

dedicated prediction market desks.

They're reportedly paying traders base

salaries of $200,000 a year to build

algorithms that systematically identify

mispriced contracts on these platforms.

So, on one side of the trade, you have a

person betting on the Super Bowl because

it seemed like fun, and on the other

side, you have a machine that does this

24 hours a day and never gets excited

about anything. This brings us to what

the gambling industry calls the sharks

and fish problem. In the early 2000s,

there was a huge boom in online poker.

Millions of amateurs, the fish, logged

on to play. But it didn't take long for

the professionals or the sharks to show

up. The professionals didn't play for

fun. They played the odds methodically,

and eventually they deployed bots to do

it for them around the clock. The

survival time of a new recreational

player on these sites was eventually

reduced to not very long. The amateurs

worked out that they were no longer

really playing a game. They were

donating their money to a server farm in

New Jersey. They stopped logging in. The

liquidity dried up and the whole

ecosystem collapsed. The sharks had

eaten all of the fish and then starved.

Today, prediction markets are full of

retail money and the platforms are

growing quickly. But unlike trading a

meme stock where the price is just

whatever the next person is willing to

pay, an event contract eventually

resolves to either true or false. There

is an actual answer. And if you're a

retail trader betting on a geopolitical

event based on a feeling and the person

on the other side of your trade is a

gamma neutral algorithm being run by a

multi-billion dollar hedge fund, the

odds are not in your favor. This is not

a skill gap that can be closed by doing

more research. It's a structural

disadvantage. When the quants have

extracted enough money from the retail

public, the excitement will wear off.

The platforms will likely be left with

sports betting, which the states will

eventually either regulate or shut down,

and a few novelty contracts that exist

entirely for marketing purposes. You'll

still be able to bet on whether Bad

Bunny wears a dress to a football match,

but the truth machine will be mostly

empty. Now, in fairness, there is one

thing prediction markets do better than

the traditional alternative. If you walk

into a sports book or open a DraftKings

account and you start winning

consistently, the sports book will

reduce your bet size, restrict which

markets you can access, or simply close

your account. This is standard practice.

The house is your counterparty and a

winning better is bad for business.

Several states have tried to pass laws

making this illegal, which tells you how

widespread it is. Prediction markets

don't do this because the platform isn't

your counterparty. It's a peer-to-peer

exchange. It just matches buyers and

sellers and takes a small fee. If you're

winning, the platform doesn't care.

someone on the other side of your trade

is losing and the platform collects its

fee either way. So in that sense,

prediction markets are structurally

fairer than sports books. Of course, the

reason you're winning on a prediction

market is most likely that you're a

quantitative algorithm. So this is

primarily good news for quantitative

algorithms. The traditional sports books

have noticed all of this. By the way,

DraftKings, FanDuel, and Fanatics have

all quietly launched their own

prediction market products while

simultaneously spending $48 million on a

super PAC to push for sports betting

legalization in states like Texas and

Georgia. So, they're fighting prediction

markets with one hand and copying them

with the other, which is a reasonably

common strategy in American business. If

you are a retail trader who's tired of

losing money to hedge fund algorithms,

you might be tempted to look for an

edge. In traditional financial markets,

acquiring non-public material

information and trading on it will

generally result in a conversation with

the authorities and eventually a lengthy

stay in a federal facility. In

prediction markets, however, insider

trading is often described by proponents

as a feature, not a bug. That's right, a

feature. If we look at recent events,

this feature appears to be working

remarkably well. Last summer, a Poly

Market user operating under the

pseudonym Rico Suave 666 made a series

of highly precise and highly lucrative

bets regarding the exact timing of

military strikes in the Middle East. It

later turned out that Rico Suave 666 was

not just a very astute reader of

geopolitical tea leaves. The Israeli

government arrested two men, including

an army reservist, for allegedly placing

bets using classified military

intelligence. So to be clear, a soldier

with advanced knowledge of when bombs

were going to be dropped used that

information to win money on what is

essentially a crypto gambling website,

which is not really what people have in

mind when they talk about the wisdom of

crowds. We saw something similar with

the capture of Nicholas Maduro. Shortly

after the United States announced the

operation, someone placed a series of

very large and very confident bets on

Poly Market that he would be removed

from office, walking away with a few

hundred,000.

It's not clear who placed those bets,

but they appear to have had a better

understanding of US foreign policy than

most of the US Senate. Now, if you ask

the operators and advocates of these

markets about this sort of thing, they

are surprisingly relaxed. They argue

that insider trading is actually a good

thing. The logic is that the insider

brings valuable information to the

market which makes the price more

accurate. The market absorbs the leak,

the odds adjust, and society gets a more

accurate forecast. This, they say, is

the troop machine working exactly as

intended. It's a rather creative

argument. If a military officer leaks

classified operational plans so that his

friend can win a few hundred,000 on a

cryptobetting site, we should apparently

all be grateful for the positive

externality of slightly more accurate

price discovery. I'm sure that the

soldiers involved in those operations

would be reassured to learn that their

safety was compromised in the noble

pursuit of market efficiency. The reason

insider trading is banned in the stock

market is fairly simple. If ordinary

investors believe the game is rigged,

that only insiders can win, they will

stop investing. And if people stop

investing, companies can't raise capital

to build factories, fund research, or

hire workers. The whole system depends

on participants knowing that the market

is at least roughly fair. One of the

reasons the US economy has been so

successful over the last 90 years is

that it's had some of the best

institutions in the world. fair

securities regulation, good consumer

protections, and a functioning legal

system. Americans invest confidently

because they broadly trust the system.

And American businesses have access to

capital because investors are willing to

put money in. In countries where

investors know they'll be ripped off,

they behave like the fish on the poker

websites did and log off. This is

extremely economically harmful.

Prediction markets don't raise capital

for anything. They don't fund new

businesses or build infrastructure. They

just move money from the pockets of

retail betterers into the pockets of

quantitative algorithms and apparently

people with highlevel security

clearances, which is a rather elegant

system if you think about it, just not

for the retail bers. You might think

that it doesn't matter. Prediction

markets aren't the stock market. But if

this market is overseen by the same

securities and commodities regulators

that oversee investment markets and the

public decide that it's all rigged, they

might not just log off from prediction

markets. They might start to wonder if

the entire system is rigged too. And

that kind of distrust once it sets in is

very difficult to reverse. So, if the

retail better is structurally

disadvantaged against quantitative hedge

funds and people with high level

security clearances, the obvious

question is what happens to them when

their money runs out. Since 2018, when

the Supreme Court cleared the way for

states to legalize sports betting, the

United States has essentially been

running a largecale experiment in what

happens when you make it very easy for

people to gamble from their phones. Now

that we've added prediction markets to

the mix, that experiment has now been

expanded to cover politics, pop culture,

and monetary bets. You can now lose

money on almost anything at any time of

the day without even getting out of bed.

The results of this experiment are

starting to come in too, and they are

not great. Recent academic researcher

highlighted by the economist shows that

the introduction of online betting in

the state is associated with a roughly

12point drop in average credit scores

along with higher rates of personal

bankruptcy and loan delinquencies.

If you make it incredibly easy for

people to gamble from their smartphones

24 hours a day, it turns out that a

rather large number of them will do

exactly that, right up until the point

where their credit cards are declined.

Now, you could argue that adults in a

free society should be able to spend

their money however they like. And I

mostly agree with that. I don't want to

be told how I can spend my money. It's

mine. If someone wants to bet their rent

money on a basketball game or the exact

date of a Federal Reserve rate cut,

that's their right. The prediction

market platforms would certainly agree

with this. They describe themselves as

neutral marketplaces facilitating price

discovery, which is a very dignified way

of describing a website where you can

bet on whether it'll snow in April. The

problem is that when millions of people

simultaneously damage their personal

finances, it stops being a private

problem. Loans start to go unpaid,

mortgages default, and eventually the

costs get absorbed by the broader

financial system. And the individuals

who fall into bankruptcy end up relying

on state and federal safety nets funded

by taxpayers who in many cases were

sensible enough not to gamble their rent

money on a basketball game. So when you

look at the mechanics of the whole

thing, prediction markets start to look

less like a truth machine and more like

a wealth transfer mechanism. The

platform takes a transaction fee. The

quantitative algorithms extract capital

from retail betterers. The insiders

extract capital from everyone and

society picks up the tab for the

bankruptcies and the unpaid bills. It's

a wonderful business model for everyone

except the people using it. Look,

prediction markets are not going to

destroy the American financial system.

The stock market survived bucket shops

in the 1920s, penny stock boiler rooms

in the 1980s, and whatever was going on

with crypto in 2021. It'll likely

survive this, too. But it's worth

noticing what has actually been built

here. a set of platforms that are

regulated as commodity exchanges,

advised by the president's son,

populated by hedge fund algorithms, and

the occasional military insider, and

marketed to 25 year olds as a fun way to

make sports more exciting. You can bet

on elections, wars, the weather, and the

wardrobe choices of regaton artists. You

just can't bet on onions because that

would be irresponsible. The advocates

call it a truth machine. The states call

it an illegal sports book. The quants

call it a new source of alpha. The

retail betterers call it entertainment.

The reality is probably somewhere

between all of these. A financial

product that is too sophisticated to be

called gambling and too simple to be

called investing. operating in a

regulatory gray zone that exists mainly

because no one in Washington can agree

on what it actually is. We haven't

really invented a truth machine. We've

just found a more elaborate way of

losing money and given it a chart. If

you found this video interesting, you

should watch my video on Micro

Strategies infinite money glitch next.

Don't forget to check out our sponsor

Plaude using the link in the video

description. Talk to you in the next

video. Bye.