Bootleggers and Baptists: XVII- Prediction Markets and Regulation (Gambling?)

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Arguably there are few methods of aggregating data that are as effective as using Prediction Markets. Prediction Markets are exchanged markets where speculators purchase “… that yield payment based on the outcome of uncertain events..” (p.877). One of the biggest misconceptions regarding this method of forming consensus on the accuracy of future events is that experts will be supplanted by amateurs. However, this concern is unfounded because of the knowledge necessary to succeed in such a speculative market. The experts would tend to dominate these markets (p.85). Separating Prediction Markets from gambling in a legal context. Dumb luck is not rewarded, but the diligent and concentrated study is. The legal lecture identifies gambling as having an element of chance (p.102). The intention of opening the trading pool to laypeople is not to give them to trade based on arbitrary “hunches”. Rather, to supplement the data pool by contributing the “on-the-ground” information absent in academic analysis (p.82).

Even though the work of legal scholar Tom W. Bell (p.102-104) demonstrates that Prediction Markets are distinct from games of chance. If a Prediction market is poorly designed, it has the potential to be subjected to anti-gambling laws (p.419). Although Prediction markets reflect the features of a decentralized form of “consulting “services than a sports betting pool (p.419). Many privately hosted sports beating pools escape prosecution due to their discrete manner. Even an in-house prediction market hosted by a corporation may raise the attention of prosecutors (p.102). It should be noted that prediction markets also face potentially regulated by the SEC and CTFC. Unfortunately, placing great barriers to entry for institutions looking to host such data aggregation markets. Prediction markets are being stifled by massive layers of red tape.

Although, it is possible under certain circumstances to be granted exemptions by regulatory agencies. 

For example, one of the best-known legal prediction markets in the United States is the Iowa Electronic Markets (IEM). In the early 1990s, the CTFC issued two no action letters granting the IEM immunity from the commission’s regulatory authority (p.25). Essentially, all federal agencies are immune from anti-gambling laws (p.419). A fact confirmed by Robin Hanson by describing the immunity enjoyed by the DARPA’s PAM project (p.77). Why not grant regulatory exemptions to all purposed prediction markets? Certainly, a novel solution. There are those voicing moral concerns and those who can prosper from prediction markets remaining heavily regulated. Presenting the classic features of any Bootlegger and Baptists coalition (1983).


One of the most evident examples of a Baptist would have to be the regulators. Despite the numerous examples of employees of regulator agencies engaging in rent-seeking and other pursuits of aggrandizement, there is still a concern for the rules being enforced. This does not mean that the rules are necessarily rational or even moral, but there is an ethical commitment to duty. Unfettered access to trading or gambling markets can result in adverse consequences for participants and the economy. If prediction markets were erroneously designed, they could operate similarly to securities and futures markets. Making prediction markets susceptible to dishonest practices such as insider trading leading to disparate effects for less privileged participants. Also, keeping prediction markets within the bounds of gaming regulations could help reduce the externalities of problematic gambling. In most jurisdictions domestically, as a condition of being granted a gaming license establishments are required to have their staff trained on awareness programs. Even requiring signage offering resources for those suffering from gambling addiction to seek treatment. If prediction markets are in theory like other forms of gambling, it could be a welcomed substitute for individuals with gambling problems. Casinos are often encouraged by state governments to implement exclusion programs for problematic patrons. The trading of cryptocurrencies, precious metals, stocks, etc. is free from the reach of gaming regulations. Potentially providing problem gamblers with a slightly different type of impulsive thrill. Prediction markets could fall into this category even if they are regulated as securities or futures commodities. If prediction markets lack age restrictions barring minors from participating. It may operate as a backdoor form of underage gambling.


  • Casinos, lotteries, bingo-halls, dog/horse tracks, and other gaming venues either online or brick-and-mortar. None of these establishments are going to take the time to research whether prediction markets are the same as gambling. Perceiving prediction markets as an alternative to gambling with potentially fewer regulations. Incentivizing vendors providing gambling services to favor any restrictions that can be placed on this potential competing form of “entertainment”. Prediction markets are a hyper-competitive form of consulting service.
  • Foreign-based prediction markets. Overseas prediction markets in countries such as Ireland provide real monetary compensation to users with leading regulatory interference (p.414). If America’s regulatory system became more friendly towards prediction markets, these existing prediction markets would lose participants.
  • Experts and professional consulting firms. Prediction markets place professional consulting firms and other subcategories of experts in direct competition with other participants. Consequently, disrupting the current status-quo of the consulting services market. Traditionally, a firm will hire a firm, freelancer, or agent of a firm to provide consulting services. Irrespective of whether the consultant is providing flawed advice, they still receive their whole salary. This is analogous to paying full price for a defective product. Even in the service industry patrons receive refunds for a lousy meal. Prediction markets resolve this issue by rewarding the consultants providing correct information. The hosting institution benefits from receiving a large pool of data for a low cost. This practice is more cost-effective than purchasing traditional consulting services. However, concurrently threatening the bottom line of consultants operating within the framework of the original model.

Bootleggers & Baptists: XVI: Terrorism and Prediction Markets

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The program was derided by Democrats and Republicans in Congress, some of whom called it “bizarre,” “unbelievably stupid” and “offensive.” Rumsfeld himself said he canceled the program “an hour after I read about it.” ( Wired ,July 2003)

Commonly, government programs engender partisanship and opportunism. Political actors are more successful to capitalize on such initiatives are controversial. This effect is only magnified when the program is headed by a polarizing figure. One prevalent example of this was DARPA (Defense Advanced Research Projects Agency) used Prediction Markets to gather intelligence on future geopolitical events. Once more contentious questions such as terrorist attacks and assassination attempts ended up being addressed, the program began to be publicly criticized.

 PAM (Policy Analysis Market) implemented by the Information Awareness Office, a counter-terrorism project ran by DARPA. PAM operated like a future exchanges market for predicting the likelihood of geopolitical events. Including but not limited to terrorist attacks. At various phases of the program, participants (consultation firms, colleges, think tanks) were provided a sum of money to “wager” on the likelihood of certain political events happening (p.77). Those with accurate answers were awarded a larger sum of money.

Figure 1

E.g.) Phase I: Participants were provided $100,000 by the IAO to wager and awarded $750,000 for accurate predictions (p.77).

Mirroring the model used in both past and future prediction markets. Dating back to Robin Hanson first pioneering prediction markets while consulting on project Xanadu in the late-1980s, these markets have always been an incentive-driven phenomenon. It is one thing to claim certainty, but it is another to be willing to die on that hill. Especially when money is on the line. Effectively aligning incentives towards accuracy and rigorous research versus armchair speculation. The objective being the firm, organization, or government department hosting the market with aggregate a large cache of quality information (p.76).In the field of counter-terrorism having averaging consensus from a variety of sources is crucial to avoid engaging the wrong target. Such mistakes will incur costs much greater than monetary losses.

As groundbreaking and innovative as PAM was invariably the program garnered some criticism that eventually devolved into outright censure. Academics and bureaucrats “betting” on the aptitude of terrorist activities and political revolts transpiring may be unsettling from a prima facie standpoint. Particularly if taken at face value with no further analysis. Arguably the criticism of PAM intensified due to the IAO’s controversial director, John Poindexter. Poindexter rose to infamy from his involvement in the Iran-Contra scandal of the Regan administration. Even though all of the insiders of the project acknowledged that Poindexter had little involvement in PAM (P. 6, footnote 7), most of the backlash was directed at him. The fury of pundits, media outlets, and the general public caused Poindexter to resign in the summer of 2003. Leaving the PAM project permanently defunct.

The advocacy and opposition to the implementation of PAM as a means of aggregating intelligence on sensitive matters is no doubt a complex maze of ethical and pragmatic arguments. The use of prediction markets for gathering information for defense planning is just like another government policy, the impact is not neutral. Meaning that keeping or eliminating the program will create disparate consequences. Typically favoring one subset of economic agents over another. Individuals will bear the “expected costs (p.38) imposed by the impact of the policy. For example, a government program may create jobs for individuals that are politically connected. However, this is generally at the expense of the taxpayer. Vice versa, abolishing a program will eliminate jobs for the clerks and managers operating the department. The impact of policy always affects some individuals positively and others negatively. All political policies involve the transfer of benefits from one party to another.

Considering the non-neutral nature of policy, it would be justifiable to apply Bruce Yandle’s concept of Bootleggers and Baptists to the political pressure to abandon the PAM program. Yes, there were some ethical concerns regarding the prospect of having people “wager” on terrorist attacks. It would be naïve to believe that all the opprobrium was motivated by morality. Much how skilled consultants can profit from participating in a Prediction Market, many actors can also do so by dismantling such a program. Beneficiaries ranging from media outlets to opportunistic politicians. The political opportunism was multilayered including enemies of the Bush administration, the Republican Party, and even direct adversaries of John Poindexter. Proving an opportunity for democrats to temporarily shed their anti-patriotic veneer, to admonish these “conservatives” for making light of national security threats. Yet, the credulous public seldomly questions this moral browbeating. On the surface, these criticisms sound valid. Since when have politicians previously disinterested in national security matters are suddenly deeply invested in the integrity of defense intelligence? As Machiavelli pointed out in The Prince appearances are more important than actual principles in politics (p.42).

The Baptists

It is exceedingly difficult to designate one side of the coalition as a pure Baptist in the public outrage campaign surrounding PAM. The self-interest of the media, politicians, resident experts within the government is glaringly obvious. The potential for Dual-Role Actors (economic agents that benefit materially, but simultaneously sincerely believe the moral argument) in this coalition dynamic exists. However, is muddied by the perverse incentives to use strawman, ad hominem, and other logical fallacies to denigrate the program. The adversaries of PAM had a lot to gain through defaming the program. Not a whole lot of utility to extract from testing the validity of the results. Since the average constituent is not going to care too much about the granular details of the program. Rather be fixated on their visceral reaction to the ethical considerations of “betting” terrorist attacks.

Regardless, of whether moral advocacy is misguided or ill-informed, nevertheless, it is still a normative position. The average citizen happens to be the proverbial Baptist in this coalition dynamic. Any expression of disgust or moral indignation was sincere with little to no observable benefit from ending the program (dispersed costs, concentrated benefits). Even if the public’s concern was stoked by the slanted framing of the program, it still does not lessen make their concerns any less earnest. In the absence of further context, a group of contractors and academics participating in a gambling pool predicting terrorist attacks does sound grotesque. Since gambling is considered a form of entertainment appears to trivialize the severity of contentious situations that could result in the loss of lives. For the honest concern for these moral considerations, the average voter is our Baptist.

One great irony was that one of the academics deeply involved in the project narrowed down the reasonable ethical concerns in a peer-reviewed paper years after PAM had been dismantled. It was none other than prediction markets pioneer Robin Hanson. Hanson citing the following as prevalent concerns of the program:

  • “…The first concern expressed—that of replacing professionals with amateurs..” (p.82)
  • “…The second fear expressed was that bad guys would be willing to make losing

trades to mislead us..” (p.82).

  • “..The third main fear expressed was that bad guys might be rewarded for doing bad things..” (p.83). E.g.) Al-Qaeda’s meddling with airline stocks in the 9/11 attacks.

Hanson tactfully addresses all these concerns explaining how much of these concerns are the result of misconception. Like how the media coverage of the program generated several misconceptions regarding the function and purpose of PAM.

The Bootleggers

Several various individuals and groups stand to benefit from a sensationalized portrayal of the PAM program. One of the more salient examples would be the media. Media outlets are a business much like another, the incentive is to maximize profits. Logically this premise is cogent to anyone with even a small amount of exposure to economics. This controversy emerged in the primordial era of social media (Myspace being founded in 2003). The internet did exist but did not present any true competition to televised and print news media. For media outlets to have a story as jarring as the government funding a macabre gambling bracket trivializing serious events, instant goldmine. That is the type of story that sells publications. It has all the elements of a good conspiratorial techno-thriller. One only needs to consider the success of Tom Clancy to know how stories of geopolitical/government intrigue are lucrative. It could be argued that the media is merely the messenger, if they happen to profit from the event, it is a natural consequence of the event. How the information is presented and sways public opinion. If news reports are worded in a manner that is hostile towards the program, this will influence public opinion. Creating a feedback loop, inciting the ire of the Baptists while concurrently profiting. This would be an excellent example of the Bootleggers tacitly inciting the indignation of the Baptists.

Another subset of Bootleggers would be the politicians who spoke out against PAM. A book could be written about the political motives guiding the strategy condemnation of the program by various politicians. As previously mentioned, the layers of political opposition operate on a continuum of scale. Varying from individual grudges, contention between political factions, and even opposition to the sitting president at the time (George W. Bush). Despite the complexities of various political considerations, speaking out publicly about a controversial government program fosters a positive public image. Especially for politicians who were affiliated with the Democratic party. During the Bush administration, Democrats were perceived as being soft on terrorism. At a time where terrorism was a hot-button issue, speaking out against counter-terrorism measures was tantamount to political suicide. The whole PAM debacle presented an opportunity for a clean slate. An opportunity to capitalize on a misstep made by the Bush administration and to feed into the fears of the public. Paralleling the Bootlegger –Baptist feedback mechanism generated by the media. See below for a shining example of such sanctimonious posturing:

For instance,” Mr. Wyden said, ”you may think early on that Prime Minister X is going to be assassinated. So you buy the futures contracts for 5 cents each. As more people begin to think the person’s going to be assassinated, the cost of the contract could go up, to 50 cents.

‘The payoff, if he’s assassinated, is $1 per future. So if it comes to pass, and those who bought at 5 cents make 95 cents. Those who bought at 50 cents make 50 cents.’ (Senator Ron Wyden (D), NYT July 2003).