Prediction Markets are for Outcomes Beyond Our Control
Betting markets are the gold standard of expert predictions because bets are the ultimate test of what people truly believe.
The best betting markets are highly liquid. A liquid market is one where you can place a large bet without moving the price very much. Liquid prediction markets work when no individual person can influence the outcome. Bettering markets are a great way to find out if “it will rain tomorrow” or whether “candidate will be elected president next year”.
But what if a single person can influence the outcome? For example, what would happen if I created a betting market for “Lsusr will publish a blog post tomorrow”?
Suppose I am ambivalent about whether I will publish a blog post tomorrow. If the price of “Lsusr will publish a blog post tomorrow” drops below 1.00 then I will buy shares of “Lsusr will publish a blog post tomorrow” and then pocket a risk-free profit by posting a blog post tomorrow. If the price of “Lsusr will publish a blog post tomorrow rises above 0.00 then I will buy shares of “Lsusr will not publish a blog post tomorrow” and then pocket a risk-free profit by not posting a blog post tomorrow.
The market equilibrium occurs even if I am unaware that the prediction market exists. Suppose the price drops to 0.99. A trader could buy shares and then pay me a small fee to influence the outcome.
I am not truly ambivalent. Suppose I’m willing to influence the outcome in exchange for $500. What happens? If the market liquidity is less than $500 then we have a functional prediction market. If the market liquidity is more than $500 then we have a regular market.
Prediction markets function best when liquidity is high, but they break completely if the liquidity exceeds the price of influencing the outcome. Prediction markets function only in situations where outcomes are expensive to influence.