Mercury's Blog

In the twelve months since I last wrote about prediction markets, the industry has matured. I wanted to take a look back at what’s happened in 2010, and think a little of what I expect in 2011.

Theme 1 – Software vendors moving up the value chain

The biggest theme to me is that the traditional software vendors (ConsensusPoint, NewsFutures, Crowdcast, Inkling Markets) have all been moving up the value chain. Where they used to provide software, they all provide a much more consultative service as well. For example:

• Newsfutures, which always had a much more consulting-style approach, merged with another consulting group to become Lumenogic. Prediction market software is hardly mentioned; they pitch consulting and strategy.
• Consensus Point has hired additional senior people, and David Perry has left. Their pitch features the consulting services much more prominently than it did in the past.
• Crowdcast has been trying to go even bigger, taking venture capital investment. And like the others, features more “solutions” than just licensing software. (Leslie Fine was a terrific hire for Crowdcast, and board member Dr. Andrew McAfee is a top thinker in the “Enterprise 2.0″ movement.
• Inkling Markets still has a great angle in the market. They appear to be a go-to company to run pilot prediction markets, and are then perfectly positioned to establish a long-term relationship if/when the trials go well. I get the sense that they tend to do less consulting work than the other companies, but will do so for larger clients. I also want to make a special mention of Inkling’s blog, which is the best one of all the prediction market companies.

Theme 2 – Free (broad) prediction markets can’t survive alone

If you think you can build a strong business on a free prediction market, you’re kidding yourself. HSX, which is great, it’s focused on a single industry and even then it’s an outlier. It exists because they’ve built a solid business selling analysis to movie studios. (Alex Costakis, the long-time CEO, left this year after Congress made it clear trading movie futures wasn’t going to happen. This meant that Cantor Fitzgerald had little reason to keep investing in trying to make a load of cash from extending HSX to do this.)

HubDub, a more generalist/news prediction market, was completely shut down because it wasn’t going to make enough (or really, any) money. Nigel, Lesley and team changed focus to fantasy sports and they seem to be doing quite a bit better.

So while I believe that very niche prediction markets associated with particular industries can thrive, it takes a lot of work to build a real business from it. And broad-based prediction markets aren’t going to make anyone any money, though they could be an investment to build traffic. (HubDub had a lot of user engagement, they just couldn’t build their prediction market into a business.)

Theme 3 – Real-money prediction markets (aka betting sites) are going strong

BetFair IPO’d in October of this year, (BET) and had targeted a £1billion market cap. They’re a very strong business, and are very well positioned if/when the US legalizes any form of betting or online gaming.

Smarkets is a startup in the betting/prediction markets market, and just recently passed £2million traded on the site. (They grew from £1million to £2million much more quickly than they grew to their first £1million.) I’ve known the CEO, Jason Trost, since he and his co-founder Hunter were doing the initial coding and fundraising in their London flat. They have a very bright future ahead of themselves.

Contrary to broad-based play-money markets, real-money betting has a solid business model that scales to become a big business. They are long-term businesses.

Summary – A market maturing

In short, the prediction market industry is maturing. I’m not naive; it’s a small market outside of the real-money betting markets. There is a solid core of strong businesses that have established themselves as the source for software and consulting and I see them continuing to grow as more companies experiment with new management tools and techniques. Niche play-money markets may also thrive, though this still remains difficult to execute.

I foresee that 2011 will be very similar to 2010: more mature and developed solutions from the established prediction market companies. It’s less interesting from an outside perspective, since there doesn’t appear to be much change. But internally I believe these companies will be an interesting place to be as they grow and work with increasingly more interesting and blue-chip clients. (And as I already said, Smarkets has a very bright future ahead of themselves in the real-money betting industry!)

I hope everyone in the industry has a happy new year and my absolute best wishes for 2011.

How did 2009 turn out?

Early this year I posted my predictions for 2009. In the best spirit of Robin Hanson (getting better predictions by simply tracking how close predictions matched reality), I want to see how I did.

• “Prediction markets in 2009 are going to become even more well-known and wide-spread, but there will be no single event that brings them to the attention of the public. It’s going to be a slow, but steady, growth.” – This was spot on. All of the vendors appear to be doing well, but there was no big “event” that brought everyone attention.
• “All of the prediction market vendors will mature their business offering/proposition.” – Not having been on the receiving end of any of their sales pitches, I can’t say this one is true for sure. But from their blog posts and public statements I would assess this as likely.
• “HubDub will continue to only be the only strongly popular play-money prediction market.” – Put me down as wrong on this one. Nigel and the creators of HubDub have focused their time and effort on FanDuel instead. (Rightly, for revenue reasons!) So while HubDub is still active, it’s not the hive of activity it was for a while.

That said, I’m still a fan of niche, public, popular sites like HSX. They managed to turn play-money prediction markets into a real-money revenue stream by analyzing trader behaviour (which can only be seen by administrators) and selling that business intelligence to the studios. This could be replicated in many industries, such as video games or television.

• “While a couple additional software vendors may appear, I get the feeling that the market for prediction market software is largely saturated.” – This was also spot on.
• “I’m looking forward to see how the CantorExchange develops.” – Not so much a prediction, but a hope that it proved interesting. It’s taken a long time to get up and running apparently, and won’t be widely launched for real-money contracts until 2010. (If I read the website correctly.)

A great development from InTrade

Just yesterday John Delaney of InTrade posted on his blog that InTrade will soon be offering some historical market data to the public for free. (As he notes, this means they’re losing a source of potential revenue, as historical data can be quite valuable.) This is a great development, and should be a solid source of data for people to dig in and get interested in how traders operate in a prediction market. Kudos to John for doing this.

Tomorrow is going to be a landmark day for prediction markets. The 2008 US election cycle has been the most-polled, most-predicted, and likely the most-analyzed election in history. It’s been going for nearly two years, and I for one am glad the election will soon be over and governing (by whomever wins) will soon begin.

But why will it be a landmark day for prediction markets? Simply put: the data.

Prediction Markets and Polls – The Data

There are prediction markets on a wide variety of sites, with both play-money and real-money incentives. Iowa Electronic Markets, InTrade, and Betfair for real-money; HubDub, Inkling, NewsFutures for play-money. There are more, but these are the sites I’ve seen cited most often. (It’s too bad ConsensusPoint didn’t push TheWSX.com this election cycle.)

More importantly, there are a few sites that offer incredibly deep (and also probabilistic) analysis into polls. Most notably fivethirtyeight.com, which I seem to be checking a couple of times a day, now. There are national polls, national tracking polls, state polls, and even some state tracking polls! Fivethirtyeight in particular does deep-level statistical analysis to determine from poll results and demographic data how likely each state is to vote for each candidate.

The number of data points, from different prediction markets, polls, and poll trendlines/analysis will be immense. The sum total of data that will be available after this election should be a treasure trove for researchers, and should finally prove the accuracy of prediction markets.

But there’s a hitch…

Yes, there’s always a hitch, and it’s something I’ve discussed before. In elections, polls and prediction markets are measuring two different things.

Polls are measuring the percentage support for a candidate. Generally around 40-60% or so, unless it’s a total blow-out.

Prediction markets measure the percentage chance that the candidate will win their election. When the election is tight, around 50%, when it’s a blowout can regularly be 95%+. (Few prediction markets exist for candidates’ vote share; really only on the presidential level.)

What should you expect on Election Day?

I expect that a number of news outlets will be quoting percentages from InTrade in the run-up to the end of polls closing in the evening. Already final results contests are springing up, including one in the New York Times where you earn points based on current InTrade odds. You can also expect a LOT of volume on the markets tomorrow. But once the results start rolling in, the news is going to focus on the candidates alone. Wednesday will start the morning-after evaluation of the polls and markets, which will likely last for quite some time.

What does this mean in the end?

Comparing the results of polls and prediction markets is certainly like comparing apples and oranges. There are certainly some similarities, but they are fundamentally different.

What we need to do is evaluate how each forecasting method performed independently. For prediction markets, that means that a “failure” (where a prediction >50% didn’t happen) is quite likely a success. For polls, that means that a result just a few percentage points off (outside its MOE) is a failure.

I believe that prediction markets will come out looking quite good in this election. They’ve already proven their worth to me; when poll results might indicate a close or tightening race in places, the prediction market magnifies the difference, and in many cases demonstrates the poll volatility is just noise.

In the end, are the results from the prediction markets useful? Based on the number of times I’ve seen them cited this year… the answer is an unqualified YES. Are they perfect? No, and neither is any other forecasting system or technique.

I’m really looking forward to tomorrow…

The US election is just over a week away, and with that there are a few different topics I’d like to touch on. With the explosion in new prediction markets since the last presidential election, we should see some interesting (but hopefully consistent) results.

• First, a great post from Koleman Strumpf on Midas Oracle points out that half of all trades on the Betfair exchange in 2004 occurred on Election Day! While I personally think that was quite likely due to the early exit poll news for Kerry and the subsequent swing back to Bush, it proves that there are still quite a few people that may be waiting until the very last day to trade.
• Jason Ruspini just started a new thread on the Prediction Markets e-mail group regarding some divergences he’s seen between prices on InTrade and fivethirtyeight.com.

  While I think some of the things he’s observed is due to the way Nate Silver presents data on his site, Jason brings up a very good point. A thorough analysis of movement in the InTrade prediction markets should be compared to the daily calculated win percentage from fivethirtyeight (where all data comes strictly from polls). I think it could be very revealing, and give the public quite a bit more data on the accuracy of polling, aggregation of polls, and prediction markets.

• A long time ago I started four different markets on Inkling Markets that will hopefully predict control over each house of Congress, and the number of seats each party will have after the election. Data is shown here:
  
  
  (as I write this, the Democratic percentage is 53.8%, which corresponds to 234 seats in the House of Representatives.)
  
  
• I may need to update my post on prediction market software soon. Xpree (founded by Mat Fogarty, and recently joined by Leslie Fine, a well known prediction market researcher from HP) may be changing their name. The top three picks according to their contest on NameThis were:
  1. Metricast
  2. UREprojection
  3. Keymet

  Personally, I don’t like #2 or #3, but Metricast sounds interesting. It also sounds like a much better fit to what they do than “Xpree.”

  Good luck to them, if they choose to go down this route.

• Do you speak Danish? Nosco is hiring!
  For English speakers, so is InTrade and Xpree.

McKinsey & Company, the famed consulting firm, recently published a roundtable interview in its McKinsey Quarterly on prediction markets. The eleven-page article (click here to access) featured a discussion with Bo Cowgill of Google, James Surowiecki, Jeff Severts of Best Buy, and Todd Henderson (an ex-McKinsey consultant).

Some of the article had the standard “what is a prediction market” explanation. (A quick reminder that you can watch my video which explains the same thing here.) But I want to point out a number of interesting notes/quotes:

• Best Buy is rapidly catching up to Google in terms of the size of the prediction market effort. At the time of the interview, Google had run 275 markets with about 80k trades since April of 2005. Best Buy had run 147 markets with 70k trades, and involved 2,000 traders. (I believe they have been active since late 2006 or early 2007.) I wrote about the Best Buy initiative after a presentation at the ConsensusPoint New York prediction market conference. While they haven’t moved quite as fast as was mentioned there, Best Buy looks to be a strong champion of prediction markets.
• Jeff Severts of Best Buy initially started doing better forecasting with a simple survey. While not as sophisticated as a prediction market (and more time consuming to calculate averages for the forecast), it generated much better forecasts than the business had ever done before. These experiences showed that they could go further with the idea.
• Bo Cowgill at Google is clearly doing the most advanced work with the underlying prediction market data. They’re the only company that I know of that looks into the underlying organisational dynamics that prediction market data can provide. (We’ve had a bit of a blog conversation about this a few weeks back.)
• Jeff Severts also noticed that any forecasts they had done about their main competitor were not very accurate. I think this speaks to a lack of diversity amongst individuals in a company when critically examining a “competition” in which they’re involved, and similar to the optimism that Bo noted that some Google traders exhibited toward similar Google markets.
• From Bo, traders were more accurate the longer they participated, and tended to be more profitable the lower they were on the org chart.
• I intend to discuss this in more detail later, but James Surowiecki brought up that it is still an open question if prediction markets “are good at forecasting genuinely discontinuous innovations or leaps.”
• Jeff of Best Buy mentioned that “support from very senior executives is essential if you want to issue contracts on anything that might be controversial.” Particularly in traditional companies, I wholeheartedly agree. While less senior executives can make good prediction markets happen within their organisational purview, any company-wide markets need the senior executive “air cover.”
• One thing that I always try to tell people when discussing prediction markets (including in the video), is that they’re really a new way to communicate within a company. I really appreciated Jeff Severts when he said:
  

  Smartly applied, this tool can help management listen to voices, throughout the company, that otherwise go unheard.

  This is a great quote, and I believe a very wise way to think about the benefits of a prediction market.

It’s great to see a well-respected company such as McKinsey publish information on prediction markets widely. This is yet another positive step toward companies viewing prediction markets as mainstream tool, and provided some interesting insights into some of the top active prediction markets operating today.