Prediction Markets: Gambling in All But Name

In a Barron’s piece today, the author of the article expressed concern that young people are at risk of falling to distinguish between gambling and investing.

The concern arose in response to the rise of prediction markets, which follow an ambiguous regulatory path that helps them evade the restrictions that apply to gambling sites. Apparently Robinhood Markets, a financial-services concern that has had its share of controversies and caters to the frenetic pace of attention-addled day traders, is diving into prediction markets with gusto.

It might shock you to learn that I am not in Robinhood’s target demographic. I am a little older than the average Robinhood client, known for busily flipping stocks while watching TikTok health advisories and exchanging hackneyed memes. I come from the grizzled tribe of staid investors who are inclined to buy and hold shares, sometimes — gasp! — for years at a time, though, admittedly, sometimes for months or even, when my spider senses tingle with intense fear and foreboding, only for weeks.

The point of the Barron’s piece was that the lines between gambling and investing might become blurred, if not eliminated entirely. I suppose the braintrust at Robinhood might paraphrase and repurpose a quote attributed to Oscar Levant, who once said: “There's a fine line between genius and insanity. I have erased that line.”

Of course, Robinhood would only be erasing the line between gambling and investing, though I’m not sure that’s better than the line deletion enacted by Mr. Levant.

There’s much in the article about how prediction markets, which set odds and take action on yes/no propositions, are technical differentiated from gambling sites.

Twirling a Mean Cue

As it happens, I know a bit about gambling. I have personal experience in games of chance and parimutuel affairs. I’m not proud of it, but I can’t deny it. It’s in my mongrel bloodline. I still remember the looks of shock on the faces of my colleagues at a holiday party years ago, their mouths agape as I strutted around the billiard table twirling my cue and making a succession of behind-the-back carom shots. I cleaned up that night, winning first prize in the billiards competition. Some asked where I’d learned such dark arts.

I’ve gambled on other things, too. I was never as resourceful as Michael Jordan, betting with his teammates on whose luggage would emerge first from the airport baggage carousel, but I’ve had my moments of impulsive caprice, my gropings in the bins teeming with blind bargains.

I’m establishing my personal credentials in this particular demimonde as a prelude to making a valid point, and here it is: These prediction markets, for all their claims of higher purpose, are not much different, functionally or technically, from things known as betting exchanges, perhaps best exemplified by Betfair, now owned by international gambling company Flutter Entertainment.

The fact is, prediction markets and betting exchanges are structurally very similar. Both are peer-to-peer markets in which participants trade with each other rather than against a house. Further, both involve a platform operator taking a commission in exchange for hosting the action. What’s important to understand is that prediction markets and betting exchange are not bookies, casinos, or houses in the traditional sense, but they still make it possible for you to gamble, and they benefit from your outlays of risk capital.

Gilding a Dubious Lily

The difference between prediction markets and betting exchanges is mainly achieved through marketing, positioning, and spin, which can admittedly make a difference to the regulatory regime to which each is subjected.

Proponents of prediction markets contend that the primary purpose of their platforms is to aggregate disparate and dispersed information to arrive at accurate forecasts. Put in those terms, it sounds as though they are selfless altruists. Meanwhile, they look down their noses at betting exchanges, which they alleged exist primarily in the seedy neighborhood of meretricious entertainment and grasping profit.

The latter part of the prediction market’s allegation is party true — betting exchanges are in the business of making money — but so are many prominent prediction markets, most notably the one owned and operated by Robinhood Markets. Also, if we’re being fair — and we always aspire to fairness here — Betfair and other betting exchanges also aggregate information as a prerequisite of providing a forum for wagering on events such as economic and political outcomes. Arguably, to the extent that gambling exchanges provide past-performance charts and “expert” selections, one might argue that even the horse-racing markets at Betfair are predicated on a particular type of obscure information and knowledge. (Anybody who’s read a racing form will know what I mean.)

Defending their ethical ground, prediction markets might pivot and reply that they attract informed traders — a better class of clientele — than the reprobates and casual gamblers who frequent betting exchanges. If you strip away pretensions, however, you’ll find that prediction markets are similarly infested with a complement of confirmed gamblers. Both types of sites arguably play host to a motley mix of reasonably informed traders, speculators, and casual participants. Perhaps a few addicts are in the crowd, too.

The prediction markets, though, are compelled to make the above claims to justify exemptions from regulatory restrictions that apply to gambling sites in many jurisdictions. This is why gambling sites are prohibited in certain markets while prediction markets are free to operate, even when they’re effectively hosting wagers. Prediction markets achieve their shaky legality and ostensible legitimacy by citing an informational purpose and an academic-research value (often spurious). These distinctions are strictly legal —didn’t Dickens’ Mr. Bumble protest that the law is an ass? — even though they cannot withstand technical scrutiny.

Finally, the cheerleaders of prediction markets resort to differentiation on the grounds of design details. They note that some of their cohort (a dwindling number) use play money, restrict participation to accredited researchers (though enforcement is typically imperfect), or feature only matters of public interest rather than the ephemera of everyday sporting events. They say all this, they make these assertions, but you will find that the largest prediction markets effectively take bets on elections or economic questions; in that respect, they are no different from betting exchanges that take wagers on the same events.

Gambling Isn’t Investing . . . And Vice Versa

The hard truth is that prediction markets and betting exchanges work in the same way and are increasingly competing against each other for the same punters. Both are venues in which participants, in the role of gamblers, can stake money — that is, wager — on future outcomes based on information, supposition, and calculations of probability. (By the way, in case you were wondering, I’ve discovered that most genAI chatbots shouldn’t gamble.)

In the Barron’s article, we find the following observations:

Incumbents like Vanguard, known for its buy-and-hold approach to investing, and Charles Schwab, which itself upended the world of retail investing in the 1970s with discounted stock trades, have steered clear of prediction markets.
“I just don’t want young people in our country to think gambling on the Monday Night Football game is the same as investing in stocks and bonds,” Rick Wurster, Schwab’s recently installed CEO, told a room of 5,000 financial advisors in November. 
“The challenge I see with this is that investing over the long run pays off,” he said. “And you have all dramatically enhanced the financial lives of your clients by helping them identify how to invest and what to invest in.”

Now, you can justifiably argue that Wurster’s comments are self-serving. Nonetheless, you’d be hard-pressed to argue convincingly that he is mistaken. As someone who has gambled and invested, I can attest that what Wurster says is essentially correct. Assiduous, well-researched investing does pay off over the long run, and long-term investments can enhance your personal wealth. I’m not rich, but careful investing is why I was able to retire a bit early and save myself from the wear and tear of airport ennui and convention foodstuffs.

When I gambled, I had a firm rule: Only bring to a game or the track what you can afford to lose. There’s always a chance — a relatively big one — that you’ll lose. If you play long enough and compulsively, you’ll almost certain lose, whether in a prediction market or on a gambling site.

In its foray into prediction markets, Robinhood endeavors to separate fools from their money. That can be done, and there’s a long history of it. In running a prediction market, Robinhood might not be bookie, but it’s undeniably keeping book. In that respect, it’s not clear that Robinhood is upholding the spirit of the eponymous character that inspired its name.