5.03.2013

More on Intrade - Revisiting a Prudent Prediction

In the comments section to a post on the prediction market Intrade the other day, long time reader Billy Ray Valentine (poooosibly a very clever pseudonym) pointed out that I had exhibited uncanny prescience in a previous post where I discussed how ripe for legal action Intrade could potentially be. The comments in question were made by me in response to Mr. Valentine's query as to how Intrade differed from any other, existing derivatives market. With Intrade in much the type of legal trouble I had predicted, I thought a post of my response might be interesting for readers. For reference, the original post which prompted the discussion can be found here.

Good evening Billy Ray,

As someone with a profound interest in derivatives markets, I suspect that you have already formulated your own opinion with regards to that question. Nonetheless, I fell compelled to respond. Therefore, what follows are my thoughts on the idea that I think you are driving at.

Depending on how one defines 'derivative', the most straight forward answer to your question is that there really is no difference between Intrade and any other derivatives market. In both cases users are writing contracts based on their prediction of whether or not an underlying event will occur.

Extending this concept, one could argue that there is no substantive difference between betting on whether President Obama is going to be reelected and writing an option contract based on a theory that a stock might decline in price. Or maybe you would prefer comparing the Obama bet to writing a futures contract based on an orange market report?

In case someone reading this thinks that I am just playing semantics games to make a point, the lack of a difference really couldn't be any clearer in some cases regardless of how you define derivatives. For example, Intrade offers contracts on Dow prices on certain dates. Contracts to do the same exact thing are some of the most highly traded instruments on futures exchanges!

So if the contracts on Intrade themselves are akin to other derivatives products on regulated markets, why isn't Intrade treated the same way as the CBOE? The most simple answer is lack of regulatory resources/desire/pressure.

My guess, and I would stress that this is only a guess (albeit based on assumptions made from following such things over the years) is that for one, some, or all of the reasons above, regulators are simply letting platforms such as Intrade be for the time being.

As we have argued on this page in the past (notably in our article review regarding Timothy Lynch's 'new paradigm' for defining derivatives), regulators and legislators are aware of these markets, and they are aware of how they operate. It is not like they are shrouded in secrecy. Something I read, if true, supports this; that is that that one cannot use US-bank issued debit or credit cards to open an Intrade account (I haven't verified this personally).

While this isn't really casting a blind eye, and while it shows at least a de minimus interest by regulators, this clearly isn't the same as blocking access, or regulating the platform outright.

Why? With the much bigger problems they are dealing with in the financial markets, the relatively small dollar amounts at stake in prediction markets and the fact that Intrade is not a domestic company, it seems probable that the powers-that-be have done a cost-benefit analysis and have decided that the resources/time to shut Intrade down are not worth the payoff. This idea is supported by something else I read about the platform, which is that the CFTC has simply ignored requests for legal clarification of Intrade's status from the company itself in the past.

Now, this 'allowing by ignoring' relationship could change at any time. Certainly US regulators have thrown their weight around when it comes to online gambling sites, even when they have been housed offshore. If some kind of scandal arose from Intrade, or if regulators decided to flex their muscles a bit, it wouldn't be a shock to see Intrade disappear at least from our shores.

However for now, while the regulators are away, the wonks will play...

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