Below, I’ve responded to the most compelling/interesting points made in Agustin’s “Predicting our own demise”

I’ll preface with the following:

A. I am biased and will financially gain from the proliferation of prediction markets

B. Agustin is a MUCH better writer than I am, sorry in advance

C. I understand that I get to nit pick and that this format does not represent a fair dialogue. I would love if Agustin responded to some of my points

My responses are in green, all other text is not mine.

@TomJrSr on X

Predicting our own demise

Creating society-destabilizing incentives for fun and profit!

August 17, 2025

Prediction markets are having a moment. :D

Polymarket daily volumes are around $30 million. Kalshi is around the same, and recently raised a funding round at a valuation of $2 billion. On the regulatory front, the SEC and CFTC seem to have given up trying to limit Kalshi's transformation into a sport-betting powerhouse, making a mockery of state-level regulations on sports gambling. Indeed, prediction markets are ascendant. So is gambling in general. The world is long degeneracy.

And what's not to love, at least on paper. Economists such as Robin Hanson have been arguing for prediction markets for decades. There are strong theoretical arguments that they efficiently and accurately aggregate information from participants, much in the same way financial markets do. And who doesn't want better predictions about the future?

I want them. But prediction markets aren't going to provide them. And if these markets get big enough, they might just kill our society.

Prediction markets are bad markets

What makes a good market?

If we want to look at what makes a good market, let's look at the best ones we already have: financial markets. The best, most efficient financial markets (such as S&P500 futures, or Treasury bond futures) have a few common characteristics:

• Standardized products: Every share of AAPL is the same as every other share (in the same share class). This fungibility allows markets to pool liquidity and increase efficiency.
• Many participants: Markets work best when they maximize the number of participants. That way there's always someone willing to transact with you when you want.
• Low transaction costs: Compared to almost any other financial transaction, trading on liquid financial markets is incredibly cheap. You can buy $1 million in the SPY ETF and pay less than $10 in fees.

This is a product of efficiency and competition, but not a characteristic of potentially efficient markets.

Heterogenous participants: Markets find an efficient price when lots of different organizations are incentivized to contribute their own knowledge and understanding. The HFT, the earnings trader, the long-term investor: all contribute their own specialized knowledge and all are necessary for a well-functioning market.

It's that last key property, that of heterogenous participants, which prediction markets so resoundingly lack. We’re extremely early to prediction markets, did these now efficient markets not once lack heterogeneous participants? Heterogeneity is a gradual, emergent property of efficient financial markets.

The missing hedgers

Fundamentally, financial markets work (and work well) because different participants have different risk preferences. This statement may come as a surprise, since we've all been taught that markets function well when people disagree with each other on the value of the traded product. While it's true that this drives a lot of trading, on its own this "belief disagreement" hypothesis would lead to almost no trading. Look up the No-trade theorem if you don't believe me. The problem is adverse selection.

Even if I have private information about some security (say that it's underpriced), I have to cross a bid/ask spread in order to put that position on. And whoever is on the other side willing to trade with me knows that the only reason I would trade is if I had private information that it's cheap. So they're going fade their offer up to the point where it would be unprofitable for me to cross the spread to trade with them. The result is no trading (or very very little trading). This is true, but only considers the immediate result among those two parties and ignores the key difference between traditional markets and prediction markets. First, traders with private information are not incentivized to trade. Over time, as you mentioned, the market will not be able to sustain liquidity and the only participants left will be those with private information. Second, in an event based market, there is a limit to the amount of actionable private information one could have in a given time frame and for a given event. In theory, on/in prediction markets, private information should have less of a negative effect than in traditional markets simply due to there being less, lead to more efficient long-run pricing, and won’t be as much of a blocker to others(hedgers) in becoming market participants.

But we do see lots of trading! The S&P500 future (ES) trades almost half a trillion dollars a day! But the reason is hedging. ES trades so much because people use it to hedge. They're transferring risk they don't want, and they're perfectly willing to pay a (small) price for the service the market provides. It's this activity that gives rise to all the trading we see in financial markets. People doing -EV trades, willingly, because those trades are positive utility for them. What's great is that they're positive utility for the other side too because the two sides have different risk preferences. Well said. This is certainly a large part of what continues to drive market volume despite some high level of efficiency. That said, to have an efficient market you need other drivers of volume than hedging, like speculation. Where do you start? With the hedgers? Or with the speculators? Are there any examples of markets that had large volumes of both in their earliest stage? Hedging is a driver of volume but its occurrence is not a characteristic of potentially efficient markets. I do believe that the # of potential parties that may be able to use a market to hedge, is indicative of whether a market can reach a similar level of efficiency as ES.

And it's precisely those hedgers, those participants with heterogeneous risk preferences, who are missing in prediction markets. There are two structural reasons.

A. I’m sure hedging is already happening, even if at a minimal scale. It would be foolish to assume multiple parties haven’t given up some EV in favor of utility or EG in recent times. Just look at the 2024 election and imagine the number of potentially impacted parties, economically, politically, and socially. The 2024 election did more volume, time-basis adjusted, than many sophisticated, traditional financial markets do on a regular basis. Are we meant to believe these were all speculators? And if so, according to your previous argument, why was there such a volume of trades happening?

B. There are clearly binary events that can provide material economic value as a market, which parties have been attempting to trade, through maximally but not fully correlated assets, in traditional markets for decades if not centuries. You can offer cheaper, less complex hedging opportunities to interested parties through binary event contracts. I’ve listed a bunch of them below.

C. It’s also worth asking how much of hedging is a result of speculation? What % of total exposure that one may need to hedge, is a result of speculation? I’d guess a large figure. In prediction markets, this does not have to be the case. Businesses, industries, and individuals, through their assets, are constantly, either indirectly or forcibly, exposed to real world events. Currently, they have no cheap or simple way to hedge against these events other than prediction markets. The value that these markets provide to others will increase as the # of market participants grow and we’ll see the same snowball effect that has been present in all successful financial markets.

Prediction markets are binaries

The outcome of a prediction market is either yes or no. One bit of information, known as a "binary contract". Binaries have been tried before. Many times in fact. And binaries have failed basically every time they've been tried. As far as I can tell, this is for two reasons:

1. They're approximately impossible to hedge, so liquidity providers hate them. Liquidity providers try to minimize risk. With a contract that settles to a continuous number, you can almost always find an instrument (usually the underlying security the derivative settles to) to hedge your risk. This makes providing liquidity relatively safe, so more people do so. With binaries, imagine the market is trading around 50%. If you're very short, you lose a lot if it settles to yes, and vice versa. But there's nothing you can do to reduce risk. All you can do is hope. That means there's a limit to how much liquidity you can provide in a given contract. All you can do is provide a small amount in a lot of contracts and hope the law of large numbers works out for you.

Event contracts ARE the underlying. They will be used to hedge exposure to both derivatives of event contracts and to exposure arising from traditional securities and beyond.  Furthermore, it's silly to think there won’t be a party willing to de-risk you for some premium, regardless of the fact that the underlying is an event. The premium may be comparatively higher, but does it outweigh the liquidity incentives provided by hedgers? Someone’s gotta hold the underlying at the end of the day, but it doesn’t make it unhedgeable.

But there's a second and more fundamental problem: it's really hard to think of what natural risks exists that get optimally hedged with binaries. Maybe I'm a political appointee and have risk to the presidential election outcome. But even that seems like (a) a tiny market, (b) it's not obvious that there's much economic risk given K Street exists, and (c) that's probably better hedged by having a good social network. I think that if you dig, most or all of the supposed value of binaries for hedging evaporates under closer inspection.

A. Sure, maybe the market is too small for you as a political appointee, but is it too small for the guy who’s taxes might increase by a few hundred dollars if you get elected? Markets all start somewhere, to use market size as an indication of whether it may in the future be economically useful is simply wrong.

 B. Do you really think K street can essentially fully de-risk you from a political failure? Past that, there is far greater economic impact which would occur past just your political career.

C. Maybe in this specific case you’re right, but just because it’s better, doesn’t mean the other doesn’t provide some utility.

It's worth noting that we already have a term for continuous-valued prediction markets: cash-settled futures. These are based on underlying asset prices and a less attractive/applicable instrument for potential hedgers(who have accumulated their exposure in ways not originating from speculation). Why would hedgers not want to get the closest they can to the actual event that they believe is going to affect their position?

Looking out for number one

The absence of natural hedgers in prediction markets ends up being its Achilles heel. Everyone in the market is either a noise trader (the polite term for "degenerate gambler") or a sharp. The former eventually run out of money, so a mature prediction market is full of people with the same risk preferences and goals: to make money trading. And that brings us back to the the no-trade theorem. I can’t imagine many entities which have accumulated exposure to ES through means of non-speculation. There are far more potential examples of parties accumulating non-speculative exposure to binary event contracts, have listed some below.

The only way for prediction markets to sustain themselves is on the back of new gamblers willing to lose money to the sharps. Is it any wonder that Kalshi, Polymarket and all the others are so pro-deregulation? After all, all the real money is locked up in institutions: pension funds, mutual funds, etc. If prediction markets provided value to institutional participants, why the obsession with getting retail onto their platforms? The answer is clear. Prediction markets only work when there is a steady supply of dumb money. This is only true for so long, markets will grow and as these markets grow more participants will be incentivized to trade.

Markets are reflexive

I can hear you saying "Ok but that's just your opinion. What if you're wrong?"

Maybe I am. Maybe a natural class of hedgers will emerge for prediction markets that I can't think of. But even if that happens, prediction markets are still bad. Possibly fatal for the kind of society we all currently enjoy. The reason is reflexivity.

Just off the top of my head
Agriculture producers: rainfall, drought, temperature, frost dates

Utility companies: average monthly temperature

Theme parks: seasonal weather affecting attendance

Airlines: hurricane frequency, snowstorms

Hotels: Natural Disaster, tourism numbers

Cruise lines: travel advisory levels, outbreak events, tropical storms

Retail chains: consumer confidence index, tourism rates

Real estate developers: interest rate announcements, home sales figures

Logistics firms: global shipping rates, port strike outcomes, export/import figures

Pharmaceutical firms: FDA approval/rejection events, regulatory changing events

Insurers: natural disasters, death counts, vaccination rates

Energy companies: OPEC output quotas, sanctions outcomes

Defense contractors: defense budget approvals, conflict outcomes, political outcomes

Imagine trying to de-risk from any of the above events in a simple, cheap manner. You simply cannot do so in today’s markets. There are virtually infinite parties with a need to hedge against event outcomes that do currently not have the ability to.

A clean prediction market

Consider a prediction market on, say, solar radiation. The sun's activity varies over time, and periods with more sunspots have higher radiation. Sometimes the sun can be pretty inactive for long periods, with corresponding effects on our climate.

So it might make sense to trade a prediction market on whether the number of sunspots exceeds some threshold. Maybe this helps farmers hedge crop prices in the event the weather becomes uncooperative as a result of reduced solar activity. So far, so good. And the reason I picked such an exotic-seeming example is that, as far as I know, we have no ability to influence solar activity. The sun is going to do its thing no matter what we do, and in particular no matter what our prediction market predicts it will do. The prediction market on sunspots doesn't causally affect the number of sunspots.

The tail wags the dog

Now consider this tweet.

The main selling point of prediction markets (other than ease-of-gambling arguments) is that they're a way to aggregate information and, through simple self-interest, create a truth-seeking mechanism. But this view completely ignores reflexivity. If the existence of a prediction market directly affects the outcome, then it's not truth-seeking anymore.

Once a prediction market becomes large enough, it transitions from being truth-seeking to being tautology-seeking.

Again, the very existence of the prediction market influences and hence distorts the underlying event that's being predicted! Hard to say it better than below

Example,

• Suppose there’s a market: “Will candidate X drop out of the election by September?”
  
• As a large trader, if you short “No” heavily, that signal could move media coverage or donor confidence, increasing or decreasing the odds that candidate X actually does drop out.
• Now, your trade doesn’t just express information; it changes the world.

This creates adverse selection against yourself,

• If your trades push the outcome against you, you’re effectively the “dumb money” paying to move the truth. If your trades push the outcome for you, the pricing will debase from reality, and the market will lose material economic value
  
• Rational market participants realize this and avoid markets where participation changes the ground truth

We've seen this before

This isn't a new phenomenon. In financial markets, we see this anytime a derivatives market becomes larger (in liquidity, trading volume, etc) than the underyling security that defines its value. And this is especially true in cash-settled derivatives, which prediction markets are by definition. We need look no farther than the recent action by the Indian regulator SEBI against Jane Street, with the latter being accused of manipulating the underlying equities market to increase profits in the options positions they held.

The same thing isn't only possible in predictions markets, it's actively incentivized.

The vibes-based economy

The Twitter user @goodalexander has written extensively about what he calls either the distraction economy or (the term I prefer) the "vibes-based economy".

1. Define "bullshit" as the irrelevance of whether something is true or not.
2. Define the vibes-based economy as one where the ability to capture the public with bullshit is centrally economically valuable.

As an example, whether what Joe Rogan says is true doesn't matter. The more he says it, the more it "becomes true" in the sense of people believing it's true and acting accordingly. Obviously the current resident of 1600 Pennsylvania Ave knows this dynamic as well as anyone.

Back to prediction markets. They're a way of disintermediating the vibes/bullshit generation process by giving participants a direct economic stake in those vibes. And now remember reflexivity. By creating an economic incentive to manipulate probabilities, the vibes can actually become true if they're even remotely manipulable. These markets will naturally die due to reflexivity as well

A concrete example

Let's consider a prediction market on "Will Trump run for reelection in 2028?" If the market is small, it's a true prediction market. It doesn't affect outcomes.

Now consider a prediction market with billions of dollars a day trading on the question. People are talking about it, thinking about it, figuring out ways it might be possible. It's now a vibe. Large amounts of societal resources are being deployed to argue for or against it. This feedback cycle directly increases the probability of the rare, changeable events through this deployment of resources.

Similarly, very probably events are made less probable. Should these forces not meet within markets and balance themselves out? Why is the trader with lower odds of realization naturally incentivized to affect the outcome more than their counterparty?

Now ask yourself if this process is good for society? I claim it's clearly not good. Because society is a tenuous, fragile thing.

• It's easier to screw something up than to make it better.

Feels like more of a worldview than having anything particular to do with prediction markets

• Salience, or vibes, of bad things have a much larger natural audience.

This is true, but it’s also true that events with “bad” outcomes generally have the most immediate economic impact to potentially affected parties. Think Civil War vs AGI. Civil war will lead to immediate collapse of industries, while AGI will take decades to integrate fully into society. It goes back to your first point here. It’s easier to tear something down than to build it up.

• The profitability of betting that a rare event will happen has a much higher upside.

So prediction markets will naturally converge much more on "will there be a civil war by 2030" types of questions than on "will we discover anti-gravity by 2030" questions. Agreed, but for the same reasons I just mentioned, these types of markets will provide more immediate economic value to potential hedgers.

Thus, the market for vibes (and hence predictions) will be dominated by irrelevant stuff that sucks economic resources (sports), or societally negative outcomes.

Sports events can also attract hedgers who’ve previously had no way to manage risk. Think about the Nets trying to de-risk from the Knicks winning the finals, think about stadiums trying to de-risk from potential ticket losses for bad team performance, there are tons of potential similar examples.

But aren't financial markets already like this?

No.

The reflexivity in financial markets (usually) leads to positive externalities, not negative ones. People plowing money into TSLA or NVDA creates risk capital to fund their competitors. New ideas get funded, technological progress happens, we all get richer, and the market becomes more efficient as a result.

The meme stock phenomenon is arguably an exception to that. To the extent that financial markets have been colonized by the vibes-based economy, that's bad thing for those markets and for the world. But that's a discussion for another day.

Conclusion

• Prediction markets are bad. They're bad market design and they induce bad incentives.
• But there's still time to put the genie back in the box.
• So let's do that.

Prediction markets provide many otherwise neglected entities with the opportunity to hedge, reward those with correct opinions about the future, and incentivize truth, not a hallucinated truth, to disseminate throughout society.