There’s a new horizon opening up for investors, which is being referred to as an “emerging asset class” by promoters and “casino finance” by skeptics. Better known as “prediction markets,” these event-based contracts have already moved into the mainstream, with brokerages like Robinhood (HOOD) and Interactive Brokers (IBKR) offering such derivatives on their platforms. More are eager to join the party, with Goldman Sachs (GS) just revealing such developments on its latest earnings call.
Next up: “I think the prediction markets are super interesting. I’ve personally met with the two big prediction companies and their leadership in the last two weeks [and] we have a team of people here that are spending time with them and are looking at it,” CEO David Solomon told analysts. “When you think about some of these activities, particularly when you look at some of the ones that are CFTC regulated, they look like derivative contract activities. And so I can certainly see opportunities where these cross into our business.”
Traditional trading involves risk, but it is calculated through technical and fundamental analysis to understand patterns and other factors. Experienced traders also have clear definitions for losses and reward ratios, and generally stick to a disciplined and data-driven approach. Contrast that to gambling or betting, where transactions are exercised based on hype, emotion, or gut feelings, with the lack of a risk management plan or the full understanding of financial dynamics.
What about prediction markets? It really depends on how these event-based contracts are used. The probability of specific changes or events (like new regulations, macro forecasts, etc.) has been used to price risks for certain stock sectors or broad ETFs—to the extent that the financial media are already including them in their news and publications. These contracts can also be utilized as precision hedging rather than complex options or higher-fee-based futures. Where these derivatives depart from the world of investing happens when the motivation shifts to speculation. Participants can treat these as binary options, or zero-sum wagers on any given outcome, which can become attractive to app users through gamification and boost the revenues of the brokerages that offer them.