If you've heard of Intrade, you probably know about the site's impressive record predicting the outcome of the last several U.S. presidential elections. Last November, traders at the online prediction market correctly called every state except Florida and Virginia. In 2008, Intrade missed Barack Obama's final Electoral College tally by just a single vote.
Trading volume in 2012 was high, with eager speculators making more than a million transactions involving 23.8 million shares. (Buying a share is essentially making a bet that a certain event will occur.) In addition to political prediction markets, Intrade offered contracts on everything from Oscar nominations to the price of gold to the birth dates of celebrity babies.
But just 20 days after Intrade's electoral triumph, the federal government launched proceedings that would eventually shut the site down. On November 26, the U.S. Commodity Futures Trading Commission (CFTC) filed suit in a Washington, D.C., district court against the Ireland-based firm, alleging that Intrade had violated a ban on unregulated options trading.
"It is against the law to solicit U.S. persons to buy and sell commodity options, even if they are called 'prediction' contracts, unless they are listed for trading and traded on a CFTC-registered exchange or unless legally exempt," David Meister, director of the commission's enforcement division, wrote in a statement heavy on both legalese and sneer quotes. The statement specifically mentioned Intrade markets pertaining to the price of gold and currencies-turf that traditional commodities markets usually occupy.
While the government cited no evidence of harm, it claimed that the rules Intrade broke "enable the CFTC to police market activity and protect market integrity." The CFTC said it would seek "civil monetary penalties, disgorgement of ill-gotten gains, and permanent injunctions against further violations of federal commodities law."
The following Monday, citing "legal and regulatory pressures," Intrade announced that U.S. traders had little more than a month to empty their accounts. "We understand this announcement may come as a surprise and a disappointment, and we apologize for the short notice and haste required to deal with this."
With the Americans out, Intrade quickly dwindled to a shadow of its former self. By March volume had fallen to a meager 50,000 trades for the year. On the 10th of that month, a somewhat cryptic message appeared on the site's main page announcing that all trading had been shut down after the discovery of "financial irregularities" that ran afoul of Irish law.
And that was that. The Intrade experiment-and much of the promise of public prediction markets-had been squashed by overzealous regulators.
Gambling for Information
"The history of financial regulation is that everything was illegal gambling to start with," says the George Mason University economist and entrepreneur Robin Hanson, one of the founders of the field of prediction markets. "Then exceptions were carved out for things that were no longer gambling. Insurance, stocks, commodities futures, options-if you look back, you'll see that all of these things were illegal. In a world where people don't see a point to it, they saw it as gambling and banned it."
Wagering and speculation have been around for a long time. A Vedic poem called The Gambler's Lament documents betting by Iron Age Indians, while records show that ancient Egyptian gambling fanatics frequently wound up working in stone quarries. But as anyone who has ever spun a dreidel on Hanukkah knows, religions have mixed views on the subject. The Greek word for justice, dike, has roots in the word for "to throw," as in dice. The Catholic Church OKs gambling in moderation as long as the games are not rigged. Officially sanctioned sports betting dates to late-18th-century Europe.
In more recent times, the technology to facilitate speculation has improved, making for faster, more accurate trading and record-keeping, and expanding the potential market of gamblers to anyone with an Internet connection. Intrade markets were little more than simple up-or-down binary contracts-a price of $0 meant the event would not occur before the date, $10 that it would-aggregated at a large scale.
If Intrade was still operating, for example, it's quite likely a market like this would be on offer: "Miley Cyrus will serve time in prison on or before January 1, 2014." Say that contract was trading at $4.99/share. Traders who think Hannah Montana's slutty alter ego is headed for the Big House should buy shares. Those who think she's already hit rock bottom and is going to turn her life around should sell.
As in all markets, more buyers drive prices up and more sellers drive them down. In the simplest reckoning, a share price of $6 was equivalent to a 60 percent probability that an event would occur. Traders could buy and sell at any time, with prices skyrocketing or collapsing based on breaking news. (Mitt's stock was suddenly a hot potato, for instance, after Ann Romney declared that her family would not be disclosing further financial data to "you people.") At the set deadline for the event, though, every market closed either at $0 or $10. On November 6, 2012, the price for "Barack Obama to be re-elected president" hovered just below $7, but the market closed on the 7th at $10.
Intrade provided something more beneficial than cheap thrills and occasional profits for participants: It generated information. As the economist F.A. Hayek explained in his seminal 1945 essay "The Use of Knowledge in Society," the prices produced by a decentralized marketplace can be a better source of information than whatever emanates from powerful central planners or even acknowledged experts. "Without an order being issued, without more than perhaps a handful of people knowing the cause," Hayek marveled, "tens of thousands of people whose identity could not be ascertained by months of investigation, are made to use the material or its products more sparingly; that is, they move in the right direction."
But until recently, Hanson notes, "information aggregation has been a side effect of markets. The main effect has been risk hedging or speculation for entertainment." By democratizing the process beyond institutional hedgers and those actively buying and selling the underlying product, Intrade attached prices to widely held political-market beliefs, generating vast troves of interesting and useful information from crowds.
Among the site's most notable predictions were correctly predicting the capture of Saddam Hussein in 2003 and the elevation of Joseph Ratzinger to the papacy in 2005. The future Pope Benedict's share price spiked in the final day before the white smoke appeared, despite the fact that the decision took place inside the notoriously secretive conclave of cardinals.
Intrade's record is far from perfect, of course. Traders at the site famously miscalled the Supreme Court's decision about ObamaCare in June 2012, showing a 75 percent likelihood that the law would be declared unconstitutional. And in the 2012 election, predictions by 538.com number-cruncher Nate Silver were generally considered to be more accurate and informative than Intrade's results, a fact touted widely by prediction-market skeptics.