Very small dollar value contracts targeted at individual retail customers are unlikely to have practical hedging utility for all but a small minority of customers when the contracts offer positions on macro level national political events. Even if such hedging were to occur, the economic benefit would be minimal. This is an inherent mismatch, and we recommend higher position limits so hedging becomes feasible on an institutional scale. 

In the same vein, we recommend margined contracts which naturally allow for greater hedging potential. We expect margined contracts and possibly even interest generating contracts[16] will provide institutional users greater liquidity with which to hedge their political risk exposure. 

We do not find issues with the proposed contract design. The economic event – whether will control the – can be modeled as a binary event, so the binary contract design matches the binary economic event and is not an impediment to hedging. 

More generally, contract design and payout are not major impediments to hedging. For example, a sufficient spread of binary contracts may be used to create a basis for hedging nonbinary economic events. Furthermore, subsequent proposed event contracts need not be binary, and there will be appropriate nonbinary event contracts to hedge nonbinary economic events.

Nevertheless, we do not take it on faith that the public will automatically take the same reasoned analysis and come to the same conclusions we have described above. We discuss some reasons why prediction markets might be perceived as threats to election integrity.

First, the financial incentives caused by prediction markets are more direct than conventional political incentives, as there is a direct payout in response to one side or another winning. This direct mechanism could be perceived as higher risk relative to its actual risk.

Second, although public perception of gambling has improved in general and prediction markets are meaningfully distinct from gambling, a minority may take offense at a financial incentive mechanism they consider to be gambling. In this case there is a focus on the mechanism of election integrity violation rather than the likelihood of the actual violation. 

Third, there is a natural inherent distrust of any new potential mechanisms of abuse, regardless of its risks relative to the mechanisms already available.

Fourth, by adding ‘skin in the game’ for market participants, the proposed contracts increase the emotional and financial investment in the outcome. When the outcome does not go according to their wishes or expectations, it increases the emotional response, which leads to stronger, albeit unfounded perceptions that the election integrity has been compromised. For example, in the 2020 elections, millions of Americans went to the polls believing that their preferred candidates would win by a comfortable margin. When the results defied their expectations, many “blue wave” traders lost money on PredictIt while suspicions about election fraud gained traction. Conspiracy-oriented traders flooded political prediction markets with bets on Republican candidates, only to suffer losses as more sophisticated traders took the other side of their bets.

Conversely, there are strong reasons to believe prediction markets will be a net positive to both election integrity and perceived election integrity, as follows. 

First, because prediction markets are inherently non-partisan, aggregate perspectives democratically and have strong incentives towards accuracy, they are less likely to be demonized by one side or another. This is coupled with the insight and social consensus-building incentives of prediction markets, as laid out in the response to questions 12 and 17. Doubts about the integrity of U.S. elections have risen in the past few years for reasons that have little if anything to do with political prediction markets. Because of the transparency of prediction markets and its active mechanisms to combat falsehood, we consider one of the primary benefits of a political prediction market to be the reduction of incentives and effectiveness of current methods to interfere with election integrity.

Second, mainstream understanding and acceptance of gaming and the benefits of forecasting have improved since the 2012 Nadex contracts, as discussed in the response to question 5. Prediction market platforms such as Kalshi and influencers within the forecasting and rationalist community are strongly incentivized to educate the public. Once election-based contracts are effectively regulated, we intend to undertake a follow up project to educate the public on prediction markets. 

Third, the opportunity to trade on election outcomes in the context of PredictIt has created powerful incentives for the public to become informed about the political process and be more cognizant of one’s own ignorance and biases. This is easily observed in discussions in the political prediction market community, which are often far more sophisticated than those in the mainstream or even professional discourse. This creates financial incentives for market participants to be rational, which in turn moves their perceptions of election integrity closer to reality. We would expect the Kalshi contracts to continue to produce a new generation of citizens whose interest in political prediction markets leads them to engage constructively in the political process and to have reasoned opinions about election integrity. 

Fourth, prediction markets themselves give signals on election integrity. In 2020, at a time when the president of the United States and a major political party were seriously entertaining the possibility that the election was “stolen”, that Trump would serve a second term, and that key Senate race calls would be reversed, market prices indicated that traders understood better than many members of Congress that the election was conducted without a meaningful amount of fraud and that the United States would see a transfer of power to Joe Biden. Reflecting widespread concerns about election integrity among the electorate, candidates since Trump have decried election fraud after losing their congressional races, but election markets on PredictIt and elsewhere have hardly moved on this news. At the same time, Congressional markets are among the most valuable sources available today to assess whether and how federal and state inquiries into election integrity will proceed. 

Although political prediction markets play a limited role currently in shaping perceptions of election integrity, recent history shows that they are more likely to increase rather than decrease confidence in U.S. elections when the public at large sees that the “smart money” is betting on the assumption of fair elections.

14.Could the contracts facilitate violations of, or otherwise undermine, federal campaign finance laws or regulations? For example, could the contracts make it easier to sidestep prohibitions governing coordination between candidate campaign committees and political action committees?

Facilitate or violate campaign finance laws
Over the course of extensive interviews with historians, practitioners, and industry leaders in both the United States and the United Kingdom, we did not come across any evidence that political prediction markets have been or are being used to facilitate violations of, or otherwise undermine, federal campaign finance laws or regulations to any meaningful degree. 

Relative to the existing mechanisms and loopholes by which parties may sidestep prohibitions governing coordination between candidate campaign committees and political action committees, the contracts do not offer a feasible mechanism to facilitate violations of, or otherwise undermine, federal campaign finance laws or regulations. 

Insofar as election markets carry the risk of undermining campaign finance laws, however, law enforcement officials are more likely to determine if this is occurring on a regulated exchange with a responsible stakeholder like Kalshi rather than a decentralized or offshore site with less incentive to police its site in line with American legal and political norms.

[31] Harry Eten, “Fake Polls Are A Real Problem,” FiveThirtyEight, 22 August 2017;
https://fivethirtyeight.com/features/fake-polls-are-a-real-problem/
[32] Yeargain, T. (2020): “Fake Polls, Real Consequences: The Rise of Fake Polls and the Case for Criminal Liability,” Missouri Law Review, 85,140-150