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Prediction Markets in the US & the CFTC — Making it all work (Part 3 of 5)

June 20th, 2008

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This is part 3 in a five-part series where I present first drafts of what I intend to send to the CFTC in response to their request for input on prediction markets or “event markets.” More background can be found in my first post here.

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This post deals with questions of Jurisdictional Determination.

Jurisdictional Determination

4. What characteristics or traits are common to or should be used to identify event contracts and event markets?

Event contracts are futures contracts contingent upon the binary result or value of a future event, such as an election, scientific discovery, business development or news item. The event contract serves to aggregate the public opinion on the likelihood of that event occurring, or the value of an event when it occurs.

Each contract has a specific criterion for judgement, which is written into the rules of the contract. Each contract also has a specific date by which the contract is judged.

12. What objective and readily identifiable factors, statutorily based or otherwise, could be used to distinguish event contracts that could appropriately be traded under Commission oversight from transactions that may be viewed as the functional equivalent of gambling?

Event contracts on the outcome of sporting events and the outcome of a random event (spin of a roulette wheel or roll of dice) could certainly be considered gambling by societal consensus. Virtually every other event contract would serve the purpose of information aggregation and not be viewed widely as gambling.

As described in part 1, where most people and institutions try and distinguish between what is gambling and what is not comes down to what is being traded. In the two examples above there is a clear consensus in American society that trading in those event outcomes would be gambling. The same statement would not be true for other events contracts.

14. Should certain underlying events or measures - such as those based on assassinations or terrorist activities - be prohibited altogether due to the social perception and impact of such events? What statutory or other legal basis would support this treatment?

Any event contract that is contingent on a law being broken should be prohibited. This would include any contract on assassinations, terrorist activities or similar events. There should never be any incentive to break a law, so there should never be any contracts that would pay someone if a law was broken.

15. Are there event contracts, such as political event contracts, that should be prohibited from trading under the Act, or that deserve separate treatment or consideration, due to the nature and importance of their outcomes? What statutory or other legal basis would support this treatment?

Event contracts on the outcome of a sporting event or the outcome of a random event should be prohibited as they are too akin to gambling.

Event contracts that would require breaking a law in order to be judged successful should be prohibited to eliminate any incentive for criminal activity.

All other contracts should be treated equally. Though some may seem deserving of separate treatment, such as political event contracts, that special treatment is simply unnecessary. Any attempt at manipulation simply becomes an opportunity for other traders to correct the market price. Even political event contracts can serve as hedging tools, as companies or industries that would be favourable to one political party over the other could hedge the risk of the unfavourable candidate being elected.

This entry was posted on Friday, June 20th, 2008 at 10:39 am and is filed under CFTC & Regulation, General, Legal issues.

Viewing 2 Comments

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    Re question 15.

    Your assertion that "contracts on the outcome of a sporting event should be prohibited as they are too akin to gambling" basically undermines most of your other arguments, in the sense that it is absolutely arbitrary and entirely subjective. Irrespective of your personal views on the subject it also smacks of pandering (making an assumption - probably correct - that the CFTC will shrink from anything that might include sports) throwing into question the basis of the logic of the rest of your arguments. Unfortunate indeed.

    As to your suggestion wrt contracts with terrible outcomes, I sympathize with your intent but also think your somewhat arbitrary exclusion weakens the overall argument in favor of these markets. Life insurance is not illegal. Deliberately murdering someone to collect said insurance is...

    Don't get me wrong, it's not always easy to come up with a set of rules that can handle even a limited number of potentially awkward contingencies well. An assasination contract on the President might well serve a useful and legitimate purpose (and an equally important challenge to 'follow the money' so that no nefarious insiders collect...) while a market on Joe your next-door neighbour would be superfluous and potentially dangerous.

    One of the reasons I think America gets so squirmy when it comes to markets in general and event markets (betting) in particular as it forces them (collectively, the culture) to face the reality that the home of the free (market) is actually a bit of a myth, and that information arbitrage, power-brokers and the apocryphal smoke-filled room still dominate every aspect of American political and business life. Very few people who have power are happy to see it seep away...especially to the crowd!
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    Hello, Sean. Thanks for your comment, and apologies for my delay in replying. (I was on holiday.)

    I agree that prohibiting sports contracts is arbitrary, subjective, and not logical. However, there is also a near-0% probability that event contracts on sports would ever be permitted by the US government. There is simply a large, vocal and politically powerful segment of the population that will not allow it, and I don't think this will change in the next generation. You may consider it pandering; I call it being pragmatic.

    My point in that argument was to instead suggest a boundary that would LEAST limit prediction markets. If the government was left to itself, I believe that they would prohibit ANY contract related to sports at all. A fair and sensible balance would be to limit contracts to the outcome of specific sporting events only, and nothing else. This would still allow a certain ecosystem of sports-related event contracts, but still allow the anti-gambling lobby a win in preventing an "online Vegas" from becoming legal.

    With regard to terrible outcomes, I think we are again largely on the same page. To use your life insurance example here; to trade on when someone will die (life insurance) would be perfectly legal since no one person can do much to affect it. But trading on a person's murder (a crime) wouldn't be allowed since one person could affect it, and there would be a significant incentive to in fact commit that crime.

    Trading on a Presidential assassination market would be morally repugnant to a large section of American society, thus even if it could potentially reveal important information, I don't believe it would ever happen. In this case I also tried to define a sensible boundary that would least limit prediction market growth.

    Whatever America's views on markets in general might be, that's not the problems we have in getting "betting" markets legalized. As I mentioned at the top, the problem is that there is a vocal and politically powerful segment of American society that believes gambling is immoral and should never be permitted. (Centered around religious conservatives, particularly in the South.) They are able to prevent anything that could be considered as gambling or "morally repugnant" from being legalized. My goal in the response above was to try and define what will never be allowed as narrowly as possible to allow for maximum growth and innovation.

    I hope this clarifies the intention of my original post.
 

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