Economists have long pushed for prediction markets. The reality is not what they’d hoped for

By Allison Morrow, CNN

New York (CNN) — Long before the founders of Kalshi and Polymarket were even born, a handful of economists were getting amped about a novel approach to dealing with one of humanity’s more egregious shortcomings: We’re bad at predicting the future.

Maybe, the thinking went, the free market could help. (This was the late ‘80s, after all, the heyday of Reaganomics, Alex P. Keaton, the twilight of the Soviet Union — what couldn’t capitalism fix?)

And so the modern prediction market was born.

But nearly 40 years into economists’ obscure academic project, the booming industry they helped inspire — a multibillion-dollar business fueled largely by sports betting — looks very different from what they envisioned.

Laws designed to strictly control gambling or gambling-like behavior made the leap from academia hard. Frustrated by the hurdles, 19 economists in 2008 laid out their pitch in a paper in the journal Science, titled “The Promise of Prediction Markets.”

With “virtually limitless” applications for businesses and policy makers, these new forecasting tools “should be freed of unnecessary government restrictions.” Regulators, they argued, should allow contracts on any economically meaningful event — elections, environmental risks, monetary policy, etc.

Since then, we’ve gotten event contracts for just about anything. The markets aren’t perfect crystal balls, and crowd wisdom can be misleading, but they’ve had some notable wins, like when Polymarket bested the leading polls and pundits to call the 2024 presidential race in Donald Trump’s favor. And traders have consistently anticipated key economic data points, like the rate of US inflation and interest rate decisions from the Federal Reserve.

But when those 19 economists wrote their dream scenario, they did so with plenty of guardrails in mind.

The markets would “presumably not include contracts on the outcomes of sports events.” And the economists made the case for capping the amount any one person could wager to a “modest sum, perhaps something like $2,000 per year” (about $3,000 in today’s dollars).

But with sports betting exploding on prediction markets, and with virtually no cap on wagers, things haven’t worked out quite how they’d imagined.

“This is not the future any of us were hoping for,” Justin Wolfers, a University of Michigan professor and a leading expert on prediction markets who co-authored the 2008 paper, told CNN.

Trading vs gambling

Today, the overwhelming majority of trades on leading prediction markets are centered on sports and pop culture — bets on World Cup penalty kicks or Taylor Swift and Travis Kelce’s wedding that, while fun, are not the “economically meaningful” events economists had in mind.

Sports are a particularly worrying aspect for public health experts.

Over the past month, sports markets and sports-heavy parlays comprised about 84% of the total trading volume on Kalshi, or about $18.5 billion, according to data from research firm TickerTracker. (A Kalshi official pointed CNN to its public dashboard, where sports, excluding parlays, makes up about half of the volume on the platform.)

The TickerTracker data indicate that for Polymarket’s US-facing site, launched in May, sports-related markets made up about 99% of the total trading volume, or about $2.1 billion, over the past month. On Polymarket’s larger international site, annual average sports volume accounts for less than 50% of the total.

Both Kalshi and Polymarket argue that trading on their platforms is distinct from gambling. They offer event “contracts” that are structurally no different from trading soybean futures. Unlike a casino or a sportsbook, the companies don’t have a “house” or a bookmaker to set odds and manage bets.

Practically, though, buying a “share” that says the Knicks will win the NBA championship on Kalshi or Polymarket looks no different from placing a bet on gambling platforms like FanDuel or DraftKings. And because US law does not treat financial contracts the same as gambling, prediction markets are available to anyone over 18.

Three economists walk into a bar…

Betting on future events is hardly new, but the modern framework of the prediction markets that Kalshi and Polymarket run can be traced to a friendly lunch in 1988, at an Iowa City restaurant called the Airliner.

That’s where three University of Iowa economists — Robert Forsythe, George Neumann and Forrest Nelson — met for food and beers and kvetching about just how badly the polls had missed the mark on the Michigan Democratic primary the day before, when Jesse Jackson absolutely trounced Michael Dukakis.

“We three said, ‘Well, gee, if we were going to predict an election, what would we do?’” Forsythe recalled in an interview. “And as economists, the thing that came most naturally to us was, ‘let’s run a market.’”

The three launched the Iowa Political Stock Market, now called the Iowa Electronic Markets, as an experiment in whether the wisdom of crowds got sharper when individual participants had real money on the line.

With just 200 traders pulled from the university staff (and wagers capped at $500), the Iowa market accurately forecast that George H.W. Bush would get 53.2% of the popular vote. Its Dukakis forecast was off by just a smidge: 45.2% versus the actual count of 45.4%.

Forsythe, Neumann and Nelson would later be among the 19 co-authors of the 2008 paper.

The promise of prediction

Forsythe, like many economists CNN spoke to, still believes in the fundamental utility of prediction markets.

Even Wolfers, who is likely the most outspoken about the harms stemming from sites like Kalshi and Polymarket, stands by the core thesis.

“A fundamental economic problem is, how do we aggregate information?” Wolfers said. “I believed back then, and I still believe, that markets are an incredibly efficient way of doing that… Most of the alternatives are pretty bad, and markets appear to be less bad.”

Economists also point to potential advantages in anticipating customer demand. Earlier this month, a Manhattan bar ran a promotion promising to comp customers’ drinks if the Knicks won the first game of the NBA Finals, per the New York Times. As a hedge, the bar put $5,000 on the Knicks winning, which netted the bar $8,000, nearly covering the bar bill.

Markets may even help combat misinformation. Columbia University researchers recently found that participating in a “climate prediction market” incentivized skeptics to learn about climate science and ultimately support climate-friendly policies. When people put money on the line, they tend to rely more on facts, the researchers told Columbia’s Insights magazine.

CNN has a partnership with Kalshi and uses its data to cover major events. CNN editorial employees are not allowed to purchase contracts on prediction markets.

Cost-benefit analysis

Economists’ dream of a highly liquid marketplace for information has, in some form, come true – with some asterisks.

“The evidence is becoming undeniable that there’s rising rates of addiction, especially among young men,” said Danny Funt, author of the book “Everybody Loses,” which chronicles the sports betting boom in America.

Funt says there hasn’t been a robust national study of gambling prevalence in more than 25 years. But a New York Federal Reserve study in March found that credit delinquencies, especially among people under 40, have surged in the more than 30 states that legalized sports gambling since 2018, when the Supreme Court overturned a federal ban.

And while Kalshi and Polymarket maintain they aren’t facilitating sports gambling, addiction experts and some state regulators say those platforms are contributing to an emerging public health crisis.

Most economists CNN spoke to wouldn’t want to see prediction markets banned, even if they are currently dominated by trivial sports and pop culture bets. Those “fun” bets bring in money, making markets more liquid, which improves their accuracy.

Robin Hanson, one of the more libertarian-leaning signatories on the 2008 paper, told CNN he doesn’t mind the sports betting and is more worried about backlash holding the industry back.

“Standard decision theory says that the value of information is informing decisions, and the world is full of people making decisions where they could benefit from being better informed,” he said. With time, bigger prediction markets will invite more competition, more customers and more legal precedents.

Eric Zitzewitz, another co-author of the 2008 paper and a professor at Dartmouth, suggested that while gambling-like behavior may be happening on prediction markets, the platforms may be getting unfairly maligned. The “fun” markets that bring customers in the door help bring attention to the more interesting markets on corporate earnings and Wall Street forecasts.

“There’s been a proliferation of really interesting markets that if you just kind of read media articles about prediction markets, you might miss,” Zitzewitz said.

Wolfers, who previously worked for professional bookies in his native Australia, seems to be the most expressly worried about prediction markets facilitating sports betting.

“If you give me the choice of unfettered laissez-faire gambling versus shut it all down…I think there’s still a reasonable case for shut it all down,” he said.

As a cost-benefit analysis, Wolfers said, the math is easy. If you have 100 people betting on a baseball game, maybe one or two of them are compulsive gamblers, he reasons.

“So then the question is: Is it worth 98 people enjoying the game a little bit more to open up the possibility of two destroying their lives?”

–CNN’s Marshall Cohen contributed reporting.

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