688. When Is a Bet Not a Bet? | Freakonomics Radio

Key Takeaway

Before putting money into any prediction market—or making a high-stakes forecast—write down what information you uniquely have, what information the other side may have, and what would prove you wrong. Treat your view as a hypothesis rather than a conviction. If you cannot name a real informational edge, do not trade; observe the market price as one input, set a spending limit, and avoid markets where insiders can influence the outcome.

Episode Overview

This episode examines whether prediction markets such as Kalshi are useful financial exchanges or another form of gambling. Advocates argue that peer-to-peer markets aggregate information and improve forecasts, while critics question their legal status, social costs, and exposure to insider trading. The discussion centers on regulation, market design, liquidity, fairness, and the boundary between hedging, speculation, and betting.

Full Transcript

Transcript of 688. When Is a Bet Not a Bet? | Freakonomics Radio from Freakonomics Radio. Auto-generated from episode audio; may contain minor errors.

When it comes to prediction markets, many questions arise. Last week, in the first part of our series, we asked an important question right in the title. Are prediction markets the best prediction tool, or is it just another casino ? In today's episode, we had even more questions. For example, when does a bet stop being a bet? More specifically, when is betting on a prediction market a form of gambling, which is typically regulated by states, and when is it trading in event contracts, which is regulated by the federal government?

These are really great questions and I enjoy discussing them. This is Tarek Mansour, co-founder and CEO of Kalshi, the largest prediction marketplace in the US . Regarding these complex issues about prediction markets, I prefer to see them as risks rather than drawbacks. As does artificial intelligence, which carries a bunch of risks: we know about the dangers of online addiction, mental health problems due to AI, and job losses . New technologies always have certain risks. I take the view that thinking critically about these risks and adopting regulation early actually promotes growth.

At least, that's the path Kalshi has taken, working with federal regulators to create a new kind of financial platform. And Mansour's ambitions go far beyond betting on sports, politics, or culture. He sees Kalshi as a new type of financial exchange. Today on Freakonomics Radio, we ask Mansour and other prediction market advocates to talk about these risks. For some topics, I would n't recommend creating a marketplace. We will also listen to the regulator's opinion. To some extent, even the stock market itself is a prediction market. And we will consider whether this case can be closed at some point .

I would not like to see prediction markets banned in the United States. The second part of our series, "The Price of Prediction, " begins now. This is Freakonomics Radio, a podcast exploring the hidden side of everything, with your host, Stephen Dubner. Tarek Mansour is the 30- year-old CEO of Kalshi, and on paper he is already a billionaire. When he talks about the power of prediction markets, he makes you think they have magical properties. For example, Kalshi is truly the most accurate way to predict the future , and it's pretty cool.

Or, capital allocation is incredibly important. And even that. This will also help overcome polarization in discussions across the spectrum. Mansour also argues that prediction markets could be a more nutritious alternative to social media. People in prediction markets read about politics and economics, they get involved, they get smarter, and they have balanced, rational thoughts, which distracts them from the content on social media that over time pushes them more and more to extremes. So how valid are these claims? It depends on who you talk to. Let's start with another proponent of prediction markets.

George Mason University economist Robin Hanson has been researching and promoting this type of market for decades. In terms of accuracy, they just consistently win. It is quite obvious: when you create a market for a certain topic and compare it with another mechanism for the same topic, the markets turn out to be the same or even significantly more accurate. Hanson has heard all the arguments against prediction markets, such as the claim that they are a slightly more sophisticated version of gambling. His point is that if you want to call prediction markets gambling, then you should consider whether our stock markets are gambling.

Conventional financial markets do indeed give people as many opportunities to gamble as they wish. You'd probably just say, "Oh, but the sports betting you allow here might be more interesting to them." So it turns out you object to the additional pleasure, not the loss of money. But you might say, "I don't want people to have that kind of fun because they lose money when they have fun." And I can answer: " Okay, okay." You want to be the one who spoils everyone's fun." Then I'll say, " Look, markets have other purposes, like gathering information, but we can roughly distinguish which markets add more information and which ones add less." So, a market for some small sporting event is unlikely to actually add information for many practical decisions.

I would just like to say: if you are going to limit people's entertainment because they spend too much money, my answer would be: allow markets only on important issues. What comes to your mind first? What kind of topics? Well, these are world events , foreign policy, national policy , politics in general, business, technology. Take a look at Kalshi and Polymarket, you'll see category headings, and many of those headings aren't that interesting to most people. I'm not against people having fun, especially since we in our society allow people to spend a lot of money on entertainment in other ways.

Even for risky entertainment. We allow people to choose risky professions: to be actors, musicians, or even journalists. Many of these would-be candidates will fail. And we allow them to take such a risk. We allow people to skydive, drive race cars, and do whatever else they want . Really. And when you talk to them, you realize that they know about the risk, but they do it anyway. It seems like you're saying that some types of betting have ethical or moral implications. Is that true? There are certainly people who find it an unpleasant form of entertainment.

And I think the idea that greed or money is involved is part of their dislike. So, someone who wants to become an actor is, in a sense, hungry for success, but people probably don't see it as greed for money. However, I see a difference between betting on yourself and taking risks yourself. I want to go skydiving . I want to become an actor, etc. Compared to betting on other people's actions, because I don't actually do anything. It seems that Scott Galloway once said that the trajectory of a young American's success is directly proportional to the time he spends on his own efforts compared to the time he spends watching others work.

Well, again, successful people often become traders in the financial markets and go into the financial industry. So this is a way to check if you are suitable for this. Remember the bet at the bar, classic bet, right? People are sitting at a bar, a controversial topic arises, someone drunkenly declares something, and another says: "No way." Did you fight over a bet? " Agreed?" It's no longer just a waste of time, it's a question of who's right, and it's a validation of your confidence, knowledge, and commitment to what you know.

It's not just about something other than yourself, it's about you and the other person, and the one who really knows best. Robin Hanson, we must remember, is an economist, and most economists believe that it is these discrepancies in information that make any speculative market work, setting a price on this difference. Here's how he explains it. Our standard simple model of financial markets is that there are two types of traders in them. One type of trader knows something and trades to profit from their information. Another type of trader trades for any other reason, and it doesn't matter what it is .

This is an employee who has to save part of their salary for retirement, or a retiree who needs to withdraw money from each payment. In any case, they have to carry out operations , but they do not have the information. These are the two types of traders in the standard simple model of financial markets. So, we call them “ noise” traders . If these are "noise" traders, then what do you call the first group, "signal" traders? I will call them wolves and the others sheep to create a vivid picture for you.

Okay, great. Wolves have information and want to use it, while sheep don't. So, wolves want to trade against sheep, not against other wolves. If two wolves trade against each other, their information is nullified, and they will not profit from this . But if a wolf trades against a sheep, then the wolf usually knows something that the sheep does not know, and therefore he will profit from such a deal. Therefore, wherever sheep gather in the markets , wolves go there . That's why Google stock is more accurately priced than cash stocks—because there are significantly more sheep, and therefore more wolves.

Presidential election markets are more accurate than Senate election markets because there are more sheep, which attracts more wolves. And one last thing to complete the analysis: manipulators are people who try to influence the price without having real information. They are sheep. For the purposes of this model, they know nothing, so the wolf will happily trade against the manipulator. In fact, the more manipulators are expected in the market, the more wolves come to counter them, and the more accurate the prices become. Let's say I'm an ambitious sheep.

I want to conduct research . I want to understand more deeply how this market works. How do I distinguish a wolf from a manipulator? The thing is, when trading in the market, it is very difficult to determine, and usually you simply cannot do it. Therefore, we have to focus on average indicators. Wolves on average expect some of their deals to be against other wolves, but they want to be where there are more sheep so the odds are higher. As a sheep, you would rather trade against other sheep than against a wolf, but unfortunately, you cannot change the fact that there are sometimes wolves in the markets, and you have to accept that.

The metaphor of wolves and sheep will be familiar to every gambler and especially every bookmaker in any casino in the world. But Hanson proves that in every market there are wolves, sheep, and perhaps even manipulators. So what about Calsee? Tarek Mansour likes to repeat that prediction markets can help democratize financial markets by opening up access to outsiders. So, you might be thinking: aren't outsiders inevitably sheep, and won't they inevitably lose to those who set the odds? Not necessarily. I asked Mansur to explain the difference between the Calsee model and the Casino model.

These are completely different things. In one case, there is a bookmaker who offers lines and you bet against him and he is against you . And this is the business model of gambling. The bookmaker sets the odds and then makes money from users. Client losses equal the bookmaker's profits, and vice versa. Over time, the bookmaker figures out who is losing the most and tries to win them back. And then he counts the winners and makes sure they don't come back again. This is not at all like the financial market, where some people lose and others win.

This is a fair and open platform, where the platform is only a neutral arbiter of what is happening . So you're describing not only the gambling industry in a historical context, but also, as I understand it, the modern online sports betting industry. Is that so? Yes. You don't need smart pros. You don't need people who are seeking the truth because they take profit from you. You need people like that in prediction markets . These are the ones who provide a large volume of trading. They make markets accurate.

They are the ones conducting the research. They are the essence of what we do. So how successful are smart pros in prediction markets? The Wall Street Journal recently reported that on Polymarket, Kalshi's main competitor, 2/3 of the profits go to 0.1 % of traders. What about Kalshi? This is Nicole Kagan, Head of Research and Market Structure at Kalshi. The ratio is approximately 1 to 2.9. What does this mean? One person will make money on the deal, and 2.9 will not. Empirically, this puts us ahead of virtually all other types of financial derivative transactions.

This is significantly ahead of the traditional benchmark , which is the bookmaker . It would be unreasonable to expect every participant in a zero-sum market to be profitable all the time. It would be strange to assume such a thing, and it is not true of any market that has ever existed. I asked Tarek about this , but I would like to hear how you explain the difference between Kalshi's business model and , say, a casino bookmaker. We are a peer-to-peer exchange. We are a CFTC-regulated derivatives exchange.

This means, also in terms of our actions, that we do not set prices. We do not set odds like a bookmaker does . I want to draw a line between this and gambling. It's Mansur again. There is speculation on Kalshi . Speculation exists in all financial markets. If you look at the ratio of hedging to speculation in any derivatives market, such as grain futures, commodities, or stock options, it is usually heavily skewed toward speculation. Speculation is needed because liquidity is needed. Liquidity begets liquidity; You know that the more efficient the market becomes, the narrower the spreads, the greater the consumer surplus, and the more trading.

In the last episode, Mansoor explained that Kalshi makes money by acting as a neutral platform , for which it charges a commission. Here's Kagan again. They are actually set parametrically. So, the lowest commissions are on the edges, the highest in the middle. We simply launch the market, and then the market itself determines the value of these things. We no longer intervene from an exchange perspective to set any prices for any events that are on our platform. We can provide incentives to encourage people to trade certain issues because we find them interesting or require liquidity.

We can reward people for participating in the markets by refunding or waiving commissions. But as a general rule, we never set prices on any of the markets on our platform. In any market, making an offer against accepting someone else's is accompanied by a risk that economists call adverse selection. Imagine you're trading the 2024 presidential election, and right before Joe Biden's terrible debate performance, you put out an offer to buy Biden's victory for 50 cents, and no one takes it. Then the debates happen, Biden's approval rating drops, and suddenly someone is happy to sell you a Biden victory for 50 cents, because the market is now pricing it at 30 cents.

Your suggestion was implemented precisely because it was outdated. To encourage people to make offers and increase liquidity, Kalshi typically charges much less from makers than from takers, and often nothing at all. But taker commissions, especially, accumulate. Kalshi claims to receive well over $350 million in commissions per month. So, while they don't operate like a casino, setting prices, Kalshi still designs incentives that determine how those prices are formed. The company also decides which betting contracts to create. The Wall Street Journal just reported on a large volume of nearly identical trades on Kalshi in the so -called perpetual futures market for the cryptocurrency ether.

These transactions may be evidence of so- called “shallow trading,” which is illegal in a regulated futures market. Kalshi denies this. The company claims that we are seeing normal trading activity that accompanies the creation of liquidity for the new product. Tarek Mansour says that while Kalshi is driving liquidity, he also feels a responsibility to create safeguards. In the sense of creating a system of checks, balances, and tools so that people can effectively manage risks and not exhibit excessive behavior. We, you see, I believe in personal responsibility.

It's not my job to block or ban, I don't even have the legal authority to do so, but I should provide plenty of warning signs, stop the advertising, and not push them in the wrong direction. Just give them all the signs and keep repeating : “Hey, you’re losing such and such an amount of money. You are exhibiting signs of unhealthy behavior. Maybe you should take a break . "Maybe you should stop." And we're adding tools like private accounts where people can follow each other for mutual accountability , and other similar solutions.

The key point, in my opinion, and a significant part of the reasons for unhealthy behavior is discriminatory marketing in traditional models, such as on regular gambling sites: we stop showing ads to winners, and we continue to lure in losers with promotions. This is something we can address at the federal level by implementing rules that prevent different types of users from being treated differently. So that you can't market your services differently to people who are most prone to these types of unhealthy behaviors. I also believe that the amount of advertising in general should be reduced.

I think we should be able to watch the game without a million commercials. Good luck with this. Yes, everything is moving in the opposite direction. I support this, but guess who doesn't like these kinds of regulations at the federal level? Tell me. Well, it's not too hard to guess, right? After the break: Where do DraftKings and FanDuel stand in the prediction markets debate? I'm Stephen Dubner. This is Freakonomics Radio. We will be back soon. In January 2025, Kalshi began offering betting on sporting events, and the demand was overwhelming.

At one point, almost 90 % of their trading volume was in sports. They currently report that this figure is around 80%, but it fluctuates depending on major events. Although Kalshi operates within the rules of the CFTC, the federal agency that regulates futures and other derivatives markets, sports betting has caught the attention of state gambling regulators . Some states have ordered Kalshi to cease operations , and disputes have ended up in federal courts. The state of New York has filed a lawsuit against Kalshi, seeking at least $36 billion.

I went back to Tariq Mansoor with some questions about this. So, I saw Minnesota Governor Tim Walz sign the state's first outright ban on marketplaces, not just sports contracts, but the entire category, with criminal liability and so on. And then, within the day, the CFTC filed a lawsuit against Minnesota to block it. So now we have the federal government going to court to essentially protect your business from the state. I think this is an unfair view of the situation. They are protecting their jurisdiction. I mean, what else would you do, right?

This is the main essence of the confrontation between the federal government and the states. Why does the CFTC even exist? They created a federal agency that operates under the Commodity Exchange Act, which is a so-called priority law . It takes precedence over state laws. Because they realized: there are many things that act like financial markets, because they have open platforms where people trade with each other, and price formation occurs. There is speculation there. These speculations are like gambling. The very reason for this debate is that there are certain similarities, but what is traded on a financial exchange will be regulated as a priority.

They will be regulated at the federal level. If states start encroaching on this jurisdiction, it will become a real problem because the same thing that happened in Minnesota could happen to Nasdaq. This can happen with futures. It can happen to anything , really. If I trade options and invest money in exchange for other money from something I don't control. I mean, it falls under the definition of gambling in the laws of about 30 states. Making it a criminal offense to trade on Nasdaq or to manage Nasdaq is a real problem.

Because you get piecemeal regulation from state to state that has proven ineffective, whether in terms of market integrity or customer protection, and it also prevents the creation of a global pool of liquidity in an actively traded financial market. I mean, obviously, you know, an agency whose sole purpose is to supersede state laws. We will determine his jurisdiction and vice versa. I saw that in 2010, when Congress was writing the law that regulates your business, Dodd- Frank, they were thinking about something like Kalshi, and there's a record from the Congressional record between Dianne Feinstein and Blanche Lincoln, and Lincoln was 100% against the projections, and now she's a lobbyist for Kalshi.

What does this mean? Was she against it? I do n't know. Anyone who knows Blanche Lincoln would tell you the same thing. I mean, this is a person with the highest decency, literally, on the planet. At the time, she said the commission should be able to stop contracts that exist primarily to enable gambling through so-called event contracts. So, you could say " Mostly"—I mean, there's a lot in that sentence, right? What is the definition of gambling? And that's the whole point. It says that we are giving the commission the authority to make such a decision based on the circumstances.

This wording is currently being debated in courts across the country. And Kalshi, as part of her lobbying efforts, has enlisted not only former critics like Blanche Lincoln, but also allies like Donald Trump Jr. The venture firm where Don Jr. is a partner also provided financial support to Polymarket, and he is on their advisory board . And the Trump administration's CFTC has so far been supportive of Kalshi. Along with Minnesota, the CFTC filed lawsuits in several other states and acted on Kalshi's behalf in Ohio. Here is CFTC Chairman Michael Selig announcing the agency's first court intervention on behalf of prediction markets earlier this year.

Over the past year, American prediction markets have faced a flood of lawsuits initiated by states . Today, the CFTC is taking an important step to ensure that these markets take place here in America and have the integrity, resilience, and dynamism that our derivatives markets deserve. So, this is the position of the CFTC of the current administration. We thought it would be worth talking to the former chairman of the CFTC. My name is Gary Gensler. Gensler headed the Securities and Exchange Commission under Biden and the CFTC under Obama.

And now Gensler finds himself on the other side of the agency he once ran. He recently filed an amicus curiae brief in a federal appeal regarding Ohio's attempt to regulate Kalshi's contracts for sporting events. The question is whether they fall under the CFTC's exclusive federal jurisdiction, which would supersede state gambling laws. I ask Gensler what it's like to challenge the agency he used to run. I like to think that filing this motion as an " amendment to the court," which I did for the first time in my life , was actually in the best interest of the Commodity Futures Trading Commission, because it was necessary to say exactly what we were trying to do in 2009 and 2010 when the Commodity Exchange Act was being amended.

This issue is now before the court . Is betting on whether someone will make a three-pointer in a particular basketball game , what has become known as a swap according to the Commodity Futures Trading Commission. And your answer then was "no." No. No. Let me explain this in the simplest terms and so on. Swaps are a form of derivatives. They are about hedging risks. Initially, it was about farmers trying to hedge the price risk of their crops. Actually invented in Japan in the 1730s for rice farmers.

And then the US adopted it in the 1850s for farmers growing corn and wheat. I take my hat off to the Japanese for this. The bottom line was: I have to plant a crop, but I don't know the price at harvest time, and I don't know how much I will actually harvest. Fast forward to the present day, let's see if we can hedge other risks: oil, gas, interest rates, credit risks, and even hurricane risks. I worked on some of this in the Clinton administration in 1999 and 2000 .

At the end of the Clinton administration, a law was passed stating that these new forms of derivatives, swaps, would not be regulated by the Securities and Exchange Commission or the Commodity Futures Trading Commission. This was done with the idea of creating some legal certainty, and that these contracts were actually between complex institutions and banks. Now, looking back, that wasn't the best decision for the American public, and part of the 2008 financial crisis was these credit default swaps and interest rate swaps. The financial crisis occurs in 2008.

Congress meets and says, "We need to undo what we did in 2000." Congress passed a reform bill called Dodd-Frank. In it, he gave the CFTC and SEC authority over the swaps market. And there was a definition of a swap, somewhat technical, which had six components. One of them had a long list of things like interest rate swaps and credit default swaps, but there was another part that dealt with contracts for events related to economic, financial or commercial risks. No, I've never heard anyone say, "Kerry, we need to cover sports betting." Simply put, in 2010, no one in my presence or to my understanding talked about transferring sports betting authority from the states to the federal government and displacing the states.

Harry Reid, then the majority leader in the U.S. Senate, was a Nevada native and began his political career as chairman of the Nevada Gaming Commission. If anyone had told Harry we were doing this , he would have stopped us. And that's because we didn't do it . So do you object to Kalshi and Polymarket's business model? We already have FanDuel and DraftKings. These are national platforms that follow the laws of individual states. 39 states allow sports betting, 11 do not . This is a business regulated at the state level.

And that's not a problem. I mean, sports betting has been around since ancient times. And most people would agree that a regulated market is better than an unregulated one, right? Yes, and now it's regulated at the state level, and it's been a traditional area of state law enforcement and police authority for many decades, I mean sports betting . Kalshi, however, claims, and they do insist, that the fundamental difference and the reason they believe they are better than DraftKings, FanDuel, Vegas casinos, or anywhere else, is that in all of these places you are betting against the bookmaker who sets the odds.

Whereas in Kalshi you bet against other players, so it's more like an open market, like a stock exchange. What's wrong with this argument? Well, that's an argument about the product. This is not a legal argument. From a legal perspective, and where they are just completely wrong , with all due respect, is that the law passed in 2010 that defined swaps was not specific as to venue or counterparty. So you can say, "Oh, my counterparty is a dealer." They are the institution. By the way, it's called Goldman Sachs.

It's called JP Morgan. If you enter into an interest rate swap with JP Morgan, JP Morgan is the institution. Do you understand what I mean? Yes, I understand. And so they don't need to resell. You can call three places and get three quotes for interest rate swaps or credit default swaps. So I think they are wrong in the legal argument about the venue . And I will say one more thing. Sports betting is swaps. This is an interesting point. I testified before Congress 54 times during the Obama administration.

I was in the room where all this was happening. We included in these reforms a provision that certain individuals, large institutions, who were called eligible contract participants , could enter into swaps both on and off the exchange. It was a big debate, and there were people like Senator Tom Harkin, who chaired the Senate Agriculture Committee and then went on to chair the Senate Health Committee. Tom said that no one should trade them over the counter, and we had to convince Senator Harkin, "No, large institutions should be able to do interest rate swaps, even if they're bilateral." But the trade-off was that the ineligible contract participants, you could call it the retail public, but I will point out that you had to have $10 million in liquid assets to be an eligible contract participant.

Therefore, an ineligible contract participant can only trade the swap in a so- called designated contract market. I will call it the stock exchange. So, all of this came into effect in October 2012 . If sports bets are swaps, then every sports bet placed since October 2012 was an illegal over-the-counter swap and was subject to voiding. Cancellation. And it probably won't happen. And it also gives you an idea of ​​the unlikelihood of it actually happening . I think that's clear. This will ultimately be discussed by nine people in a small conference room in Washington, D.C., and it's called the Supreme Court.

None of us will be in that room. Under current rules, Kalshi's income is taxed as ordinary corporate income. Bookmakers pay this too, but they also pay a tax on gross gaming revenue, about 7% in Nevada, 36% in Pennsylvania, up to 51% in New York. States impose high taxes on sports betting in part to offset the social costs of gambling, but also because it is safe money. But prediction markets like Kalshi don't pay these gambling taxes, which creates a nice profitable loophole. Critics call this regulatory arbitrage.

Tarek Mansour from Kalshi is with us again. If we are doing regulatory arbitrage and it took 6-7 years to get started, then we did a bad job. Regulatory arbitrage is when someone takes a shortcut to build a business outside the rules. We actually worked hard for 4 years before launching our product to get regulation from the federal government. Obtaining a financial exchange and clearinghouse license is significantly more stringent than regulation by one of the 40 states, which are sort of competing for customers' business. So, changing the tax structure would threaten Kalshi's business model, but there are other, even bigger risks.

More about this after the break. I'm Stephen Dubner. This is Freakonomics Radio. Since the vast majority of Kalshi’s transactions are now sports betting, and Kalshi’s right to offer them faces serious legal challenges , Kalshi’s model itself is quite risky. Another risk is insider trading. Over the past few months, Kalshi has disqualified several current and former U.S. political candidates for betting on their own races on the offshore platform Polymarket, which trades cryptocurrency , not dollars. One US Special Forces soldier made $400,000 betting on a raid to capture Venezuelan President Nicolas Maduro—a raid he helped plan and execute.

He also tried to open an account on Kalshi, but Kalshi blocked him. George Mason University economist Robin Hanson, a longtime proponent of prediction markets, has a more nuanced view of insider trading. Speculative or betting markets are an information institution, just like journalism. Journalism is supposed to gather information, synthesize it into news, and then disseminate that news to the world. Journalism, in fact, often tempts people to reveal information they promised to keep secret. Many famous news stories are based on this. And we, as a society, have a certain compromise here.

On the one hand, we want to receive more news, and news is a value. On the other hand, perhaps there is some value in organizations keeping secrets as well . The same trade-off exists in speculative markets . If one of the main values ​​of speculative markets is their prices and the accuracy of prices that provide us with information, and the institution itself invites people and pays them to contribute information, then of course this will be the greatest temptation for those who have the most information. And according to the logic of the institution, this is exactly what it and we should want.

On the other hand, there may be other societal problems that we sacrifice for the sake of more accurate prices in speculative markets. And I think that's the right way to look at things. We should neither guarantee that all secrets are always kept as a universal law, nor demand that all secrets be revealed. We must allow this competition or compromise between organizations trying to keep their secrets and news and other information institutions trying to learn the truth about the world. I presented Robin Hanson's argument to Gary Gensler, the former CFTC chairman, whom we heard from earlier.

The argument of Robin and those who support him is that markets will incentivize people to disclose information more quickly. An insider at Apple or Google will make this information public because they will profit from it . But I believe that the price, and a very real and serious price, is trust in the markets. Those who say : "Let's financialize information and say that insider trading is not prohibited." They don't understand that this will have a cost to our capital markets as a whole, and there will be less trust in our capital markets, and anyone trying to raise money in those markets will probably get a slightly lower price-to- earnings ratio.

Literally, the cost of capital will increase. Now, for individuals, this is also an unfair deal. Are you saying that someone else will have inside information about whether the president is going to bomb Venezuela tomorrow? To me, this just undermines the capital markets. And what does Kabbage CEO Tariq Mansour think about this issue? Do I believe that insider trading should be banned? I think it should. This is not even just a philosophical question. This is very pragmatic. Some of our competitors say we should allow this because it makes markets more efficient, right?

He said it provides information faster. But you can make the same argument for the stock market. So why is insider trading prohibited in the stock market? Well, because if the game is inherently unfair, if the thing is unfair, who will participate? Maybe I'll give an example from the stock market, because you can imagine that if I represented a pension fund and I knew that the executives of the companies I wanted to invest in were trading their company's stock through insider trading, well, that's very valuable information for me as an outsider.

So, why do you think this is not a good idea? Because the people on the other side of these deals will eventually realize that the game is rigged and stop trading. And someone has to lose. This is a market where there are no fair rules of the game, right? If you have access to unique, differentiated information through your job, government access, or insider status, you will have an innate advantage. Okay, so these are the reasons why you don't want insider trading on Kalshi. And what do you do about it?

The same thing that NYSE and NASDAQ do with it. So when you ban it, secondly , you are conducting what is called surveillance . First, you must conduct KYC for everyone participating in the market. KYC is “know your customer”, right? Yes, you should conduct customer due diligence. You have to identify them, essentially. Who they are, where they live, all that. And it's the same as when you open an account at Schwab. Every trader on Kalshi, what do you call them? Yes, trader, user. They undergo KYC.

The American platform Polymarket does this too, but their offshore platform, as far as I understand, does not. I don't know what they do today, but historically yes, they don't do KYC. You can access the offshore platform that makes up most of the product by simply sending Bitcoins and you start trading. You don't need to say who you are. But I believe this is a key pillar in identifying scammers, because if someone is committing fraud, you don't even know who they are. How to catch them? Secondly, you monitor .

So, essentially, any suspicious behavior patterns on the exchange are flagged by our system. Give an example. Something was trading at 10%, and suddenly there was huge buying. And a day later, a loud statement appears, raising the figure to 40%. This is suspicious. What about small sports bets, such as whether there will be a double fault on the third point of the fourth game of a tennis match in Macedonia? We don't do that. We do not do micro-betting. I think it's because they carry increased risks, but it's not limited to that.

In general, not 100% of the time when people commit fraud, they do n't do it for $10. You wouldn't commit a federal financial crime to make $10. The next step is an investigation, and this could lead to fines or criminal prosecution, just like in the traditional stock market. Now, Cashier takes it a step further, which most financial markets don't actually do. We proactively prohibit people from trading what they can control. There are all these lists that will tell you, " Hey, who is a politically significant person?" And about what?

There are lists that show all the athletes, coaches, and people around them for a team, league, etc. We use these lists proactively: when someone registers and provides us with their information, we block them from trading in markets they can influence. We act a little conservatively, like we block with excess, and if people tell us they don't really have an impact and prove it, we let them trade. How much information do you have about your customers? Do you know exactly what they do? Do you know exactly where they live?

Do you have their bank account etc.? There's a lot of data there: name , address, social security number. There are all these KYC providers. There are a lot of them . We use the services of many of them. They can provide you with a complete profile with a high degree of confidence and do it fairly quickly. And sometimes not, and then you have to refer them for further review and verification, right? This system is becoming very complex, and we have been building it for years. But in short, we know a lot about our clients.

How important do you think your impeccable, " scout" stance on insider trading is in Kalshi's success story? You've spent a lot of money and many hours trying to appear as legitimate and law-abiding as possible. I'm curious if you see this as a necessary driver of your success, or is it just a way to " get in the door"? Definitely the first. If people eventually stop trusting the market, they will simply stop trading. Also, if you're a fraud or an insider and today you want to, you know, engage in insider trading.

Will you go where there is regulation, where all your deals are reported to the government, where everything is transparent and you have to identify yourself, or where there is none of that? I wonder if offshore prediction markets are much better suited to scammers, right? They don't know who you are, you just send bitcoins and get paid in bitcoins. I think legislators are increasingly paying attention to the fact that the prediction market is becoming an increasingly large industry. It's Nicole Kagan from Kalshi again. I worry that we might be perceived as one entity, even though in reality we are two completely different entities.

The two structures she is talking about are Kalshi and Polymarket. Polymarket's American division has stricter regulations, but their offshore cryptocurrency platform is much more liberal. The first thing I'll say is: we collect all the information about customers, but they don't collect it at all. Second: each market on our platform has a business rationale for its existence and a list of sources we rely on to settle outcomes. Polymarket is fundamentally different in its structure. There are no clear contractual rules in their markets. Sometimes they have a paragraph or two that outlines the rules of the markets and possible data sources, but they are settled by voting using third-party cryptocurrency tokens.

So we have an extra layer of protection: we identify reliable data sources for market settlement and only create markets for those events that we consider important enough. There are certain markets that we simply will not place because we believe we have no real way of understanding the outcome of the underlying event. So, we have a robust set of rules available on the page of each hosted market. These are legal contracts that people sign when they trade in these markets. Kalshi simply followed all the rules, applied for a permit, and received it.

This is economist Robin Hanson again, who has been watching prediction markets for a long time. In the 2000s, there was the Hollywood Stock Exchange, which created movie markets, and they were actually quite accurate and informative. These were virtual money markets, and they decided to go through all the legal hurdles to create real money movie markets. A few months before the launch, the film studios learned about it and lobbied Congress for a ban. And this was only the second type of futures market to be declared illegal.

The previous one was onion futures in the 1950s. So Kalshi also took such a risk, but they were lucky and they are acting legally. There is a risk of a negative reaction. We have to admit it. Prediction markets have grown very quickly without warning, and a lot of people don't like them, so there is an attempt to strike back, and they may win. Polymarket chose the crypto path, where they could ignore regulations more . I'm sure they say they follow the rules, but the point is that they could have easily circumvented them.

And if there is a negative reaction, Kalshi will suffer more because they are more closely supervised by regulators. Polymarket will more easily survive any blow. And Kalshi may soon have other competitors. I asked Tariq Mansoor about this . I saw that DraftKings and FanDuel, the big online bookmakers, now not only operate their own prediction exchanges, but also withdrew from the American Gambling Association, which opposes prediction markets. Does this mean that DraftKings and FanDuel are after you, especially considering that over 80% of your current deals are sports betting?

I hope they invest more in prediction markets, and I hope others do too. I think competition is good. Moving away from this unhealthy, addictive gambling model to a more open market model is a good thing. This creates a larger consumer surplus and is better for the consumer in the long run. I hope more people do this, and I think it will expand the market. People keep forgetting that for all of these products, whether it's cryptocurrency, prediction markets, or even traditional markets, a huge proportion is still offshore.

The fact that regulated domestic players are reclaiming territory in places where the Wild West reigns is a good thing. I know that among your allies are former White House officials from the Biden and Obama eras, there is Donald Trump Jr., as well as some cryptocurrency firms. At least from the outside, it looks like a rather strange combination. What do you think are the biggest risks for you in the future? What do you most hope to protect yourself from? Look, there is politics, and it's just part of the reality of the modern world.

Always, as far as I'm concerned. Perhaps prediction markets will help to reduce the degree of this polarization a little. For example, climate change, is it real or not? Maybe let's ask the market. Let's stop having different answers every 4 years, okay? That would be great. We have a lot of people, very smart people, working on this. We have advisors from both camps, but my focus as CEO is to make sure we build a great product for people, and I think that ultimately makes all the difference.

Because all this fighting, you read articles about how, they say, prediction markets—people are losing money. All these articles, I mean, do you know who is founding them? This is the casino industry. And partly Wall Street too. Because it is a threat. Do you have evidence of this? They've even been doing it publicly on Twitter lately. I do n't even know if it's a secret. If it's a secret, it's definitely not a very well- kept one. The bottom line is that it's like Uber, like Airbnb. Taxis don't get out and say, their message is usually not: " Hey, we have a monopoly now." We don't want this because this competition will reduce our profits." What do they say?

That other guy is evil. Yes, Uber is dangerous. Are you familiar with the concept of pre- mortem? Yes. So, pre-mortem for Cult Beauty, please. You have been forced to think about the many potential complicating factors for years to build this business. If Cult Beauty were to disappear or collapse in some way in the next 10 years, why would it happen? And how do you protect yourself from this? I think we failed to overcome some cases of insider trading. I feel pretty confident about this. The second point brings us back to the need for a healthy balance.

I imagine it as a highway. You need a highway that is wide enough and well-maintained so that innovation can flourish. So users can come, explore, trade, make mistakes, learn, grow, and do much more. But on the side of a highway like that, you want to have protective barriers. You need a fence so that you can't really fall off the cliff. Mistakes with these barriers or the fact that society doesn't accept them quickly enough. And I do n't think this is just about prediction markets. Kalshi has ambitions that go beyond prediction markets.

How do you see Kalshi in 5 years? Do you want to replace Nasdaq or the New York Stock Exchange? I really want to build the next generation financial market . One that can reach and engage a much wider range of people and keep up with the speed and dynamics of change. Kevin Hassett wrote about this a few years ago: the idea is that as society becomes more complex, the entropy of the system increases, which means that the pricing of our traditional assets deteriorates over time. Today, if you want to have accurate pricing of the S&P, housing prices, or other assets, you have to have a very good understanding of AI.

You must have a very good understanding of geopolitical risks. You must have a very good understanding of public health or new COVID or hantavirus outbreaks. All of these factors are independent measurements that ultimately affect the prices of our assets. There is a theory that I think applies: you need to have an infinite number of markets to cover all these dimensions and effectively evaluate them. Creating prediction markets for all these various questions will allow us to better evaluate them, reducing the entropy in these questions, which inevitably reduces the entropy in our overall understanding of the world.

As we heard today and last week, it is still an open question whether Kalshi and other prediction markets will achieve success in the long term. It depends on whether they can be properly regulated and on who will exercise this control. It also depends on whether they can withstand public opposition. Judging by the comments we received after the first episode of the series, some of you are adamantly against the very idea of prediction markets. What if these markets still flourish? What if public opposition isn't enough to stop them?

And here's Robin Hanson again. Unless successfully countered, these markets will obviously grow. They will get legal precedent. They will develop the infrastructure. They will introduce them to customers. I would say that any innovation is a combination of simple elegant ideas with a bunch of complex details. And these elegant ideas don't really change the world until someone explores the space of different details to understand which ones will help bring the ideas to life. Thanks to Robin Hanson of George Mason University, Tarek Mansour and Nicole Kagan of Kalshi, and former CFTC and SEC Chairman Gary Gensler.

Let us know what you think about Kalshi and other prediction markets. Our email address is: radio@freakonomics.com. Meanwhile, on the next episode of the show: No one can actually magically make beef prices go down. Ultimately, this is a story about demand. The most important thing for your listeners to know about the skyrocketing price of ground beef right now is that it reflects this entire crisis. Why are beef prices so high? The answer is not as simple as you might think. More about that next time on Freakonomics Radio.

Also, please watch the television talk show we are creating. It's called "Better in person." You can find it on the Freakonomics YouTube channel, as well as on Apple Podcasts. We'll be back here in a week with a new episode of Freakonomics Radio. In the meantime, take care of yourself . And, if you can, take care of someone else. Freakonomics Radio is created by Wren Bud Radio. You can find our full archive on any podcast app. It is also available on freakonomics.com, where we publish transcripts and episode notes.

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