NerdWallet's Smart Money Podcast - Prediction Markets Let You Bet on Just About Anything — But There Are Risks

Episode Date: November 20, 2024

Learn how prediction markets work, the legal gray areas in which they operate, and how they could be regulated in the future. What are prediction markets like PredictIt, Polymarket and Kalshi, and how do they work? Is it legal to bet on elections in the United States? Hosts Tess Vigeland and Anna Helhoski welcome Sam Taube, the writer of the Nerdy Investor email newsletter, to break down how event contracts operate, explore the legal gray areas of election betting, and discuss whether prediction markets are a smart financial move—or just gambling in disguise. Then, Tess and Anna break down this week’s money headlines, including the latest inflation figures and what they mean for interest rates, the CFPB’s plan to enforce new click-to-cancel subscription rules, and Spirit Airlines’ Chapter 11 bankruptcy filing. In this episode, the Nerds discuss: how prediction markets work, betting on elections, event contracts explained, investing vs gambling, election betting legality, gambling vs investing, Commodity Futures Trading Commission, event contracts legality, prediction market regulation, prediction markets news, event contracts explained simply, and Consumer Price Index. To send the Nerds your money questions, call or text the Nerd hotline at 901-730-6373 or email [e-mail]. Like what you hear? Please leave us a review and tell a friend.

Welcome to NerdWallet's Smart Money Podcast. I'm Tess Vigeland, in for Sean Piles. And I'm Anna Helhosky. And this is our weekly money news roundup, where we break down the latest in the world of finance to help you be smarter with your money. We'll go deep into a single topic, then leave you with the latest money headlines. Today, we're talking about prediction markets. These are companies like PredictIt and Kalshi. We're going to talk about what they are, how they work, and how the election has raised their profile. Joining us is Sam Taub, the writer of the Nerdy Investor email newsletter. Sam, thanks for joining us again. Happy to be here.

So you've mentioned prediction markets in some previous episodes. You've also mentioned something called an event contract. So let's start with that term. What are event contracts? An event contract is a type of investment instrument that lets people speculate on whether a particular event will happen or not. That event might be something finance related, like will the S&P 500 close above 7,000 points by the end of the year? It can also be a political question, like will Donald Trump win

the presidential election? Or it can also be something sports or pop culture related. In the last couple of weeks, people have used Polymarket and have traded event contracts on Polymarket to speculate on the outcome of the Mike Tyson, Jake Paul fight. Event contracts can cover any kind of yes or no question that will get a definitive answer at some point in the future. And how do these things work? Event contracts have a face value in dollars, and that's typically $1 per contract. But in the lead up to the event in question, traders can buy yes or no positions on the contract for some amount between $0 and $1 that is determined by the market. It's the market's odds that the thing will happen.

Once the event happens, or doesn't happen as it may be, and we get a definitive yes or no answer to the question, then the contract pays out $1 to whoever was right. For example, suppose you paid $0.25 for a yes position on a contract about whether the S&P 500 will close above 7,000 by the end of the year. Then suppose that actually happens. You'd receive $1 from your 25 cent investment, so you'd be quadrupling your money. And if you bought a 25 cent yes position on a thousand contracts, you'd get $ thousand dollars from an initial investment of $250. So event contracts let you bet on future events. What are prediction markets? Prediction markets are the online trading platforms where people can buy and sell yes or no positions on event contracts. Predicted PolyMarket are some of the biggest prediction markets,

although PolyMarket's technically not available in the US. There's also another big one called Kalshi. Then there are a couple of conventional stock brokers, Robinhood and Interactive Brokers, that actually operate their own in-house prediction markets. There are a couple different ways to make a profit in these kinds of markets. You can either buy a position and hold it until the event in question and make money if your prediction was right. You can also potentially buy a position and then resell it to another trader for a higher price before the event in question. All right, Sam, honestly, this sounds a little bit like gambling. And some listeners might be surprised to hear that you are allowed

to bet on elections. That's legal. That's a good question and an unresolved question. Yes, prediction markets are definitely one of those things that's kind of in a gray area between high risk speculation and gambling, along with small cryptocurrencies and meme stocks and things of that nature. When it comes to the legality of these things, that is also an open question. Until recently, as you mentioned, election betting has generally been considered illegal in the U.S., in part because there's a concern that it could harm election integrity. It could create an incentive for someone to stand for an election as a candidate

and then lose deliberately for a betting market payout or something like that. Regulators, including the Commodity Futures Trading Commission, have been trying to shut down these election-related prediction markets on that basis, among others. As I mentioned earlier, polymarket, which I believe is the biggest of these things, is blocked in the U.S. The regulators managed to shut it down in the U.S., although that hasn't stopped some U.S. users from accessing it in various ways through various kinds of internet technologies. But the rest of these prediction markets are de facto legal for the time being because of a decision in an ongoing court case between Kalshi and the CFTC. Back in October, a federal appeals

court ruled against a CFTC effort to block Kalshi's event contracts from trading while this court case plays out. That doesn't mean that Kalshi's event contracts from trading while this court case plays out. That doesn't mean that Kalshi won the case or that prediction markets on elections are definitely legal, but it might turn out that way. And the courts have given these markets the green light to operate until that case is decided. So that's how people were legally betting on this recent presidential election, semi-legally anyway. On a related note, does Trump's win mean anything for the future of prediction markets? Yeah, I think that this election outcome was a very significant moment for these things for a couple of different reasons.

For one thing, this was a very high profile case of prediction markets making a correct prediction when a lot of other experts didn't or were a little more ambiguous. If you looked at election models or poll aggregators in the days leading up to the election, most of them showed just a 50-50 coin toss. But the prediction markets were different. Most of the major prediction markets favored Trump and won. Does that mean that prediction markets are perfect crystal balls? No, this is a sample size of one event, but it's a very significant vindication. So it's vindication. What does Trump's victory mean for the regulation of these things? You mentioned that's an ongoing issue as

well. Of course, it's a little hard to predict what exactly the incoming administration will do, but there are some early indications that Trump might be fairly lenient with these things, particularly compared to what a democratic administration might have done. After all, downsizing the government and cutting regulations, particularly regulations on the financial sector, was a pretty consistent theme of Trump's campaign. For example, he's been very critical of Gary Gensler, who's the chair of the Securities and Exchange Commission, in part because he feels that they've been too strict on things like cryptocurrency and other new financial technologies. There was a

Reuters report a few days ago that said that Trump might appoint Dan Gallagher, who is currently the chief legal officer of Robinhood, to lead the SEC instead. Again, Robinhood is one of the platforms that has allowed investors to speculate on this recent presidential election using event contracts. So if Trump puts their top lawyer in charge of a major financial regulator, that would probably signal a green light for these types of prediction markets. Sounds like we might be hearing more about these things in the year ahead. Sam, can you tell us a bit about the risks of prediction markets? Are they something that most investors should be participating in? Before we get into that, we have to do our little disclaimer here. We're not financial advisors. This podcast is not financial advice,

and everyone's needs and circumstances are different. Having said that, there are a couple reasons to be cautious about putting money into prediction markets. For one thing, they're not long-term investments. These are short-term bets, and they're everything or nothing. If you're investing for a long-term goal like retirement, most advisors are going to steer you toward passive investments that slowly but consistently grow your money over time, index funds and things like that. Event contracts are much, much riskier than that. Also, we talked about how prediction markets are kind of like gambling. And I mean, in some cases, like the people betting on the Tyson-Paul fight, that very literally is gambling. As we all know, gambling can be addictive. If you're on track

to meet your financial goals and you have some extra money and you really want to dip your toes into prediction markets just for fun, there are some guidelines that are probably worth following. Don't bet any more than you can lose. Treat your bets like they're entertainment expenses, not like they're investments that you're expecting to get back. Just like when you walk into a casino in Vegas. Yep. We should also mention that if you feel you have a gambling problem, there are resources available to help. The National Council on Problem Gambling offers a phone helpline at 1-800-GAMBLER. That's 800-426-2537, as well as text message help at 800-GAM, and also an online chat to help on its website. Sam, thanks so much for joining us. Thanks for having me on. And if listeners want

to learn more about this, we're going to be writing about it in the upcoming issue of the Nerdy Investor newsletter. Go ahead and subscribe to that. Up next, we've got a few money headlines from the last few days. Well, Anna, the Labor Department reported on the latest inflation figures, and hey, guess what happened? What? Not much. The Consumer Price Index ticked up two-tenths of a percent in October. Prices were up 2.6% over the same time a year ago. That was higher than the 2.4% rise in September.

So-called core inflation, which strips out volatile food and energy prices, stayed steady at 3.3%. That core inflation is a key economic indicator that the Federal Reserve looks at as it's deciding what to do with interest rates. The Fed's long-term goal is 2% inflation. So we're not there yet, but we're still way, way down from the peak inflation of June 2022, which was 9.1%. Yeah, the Fed's current campaign of lowering interest rates began in September with a half percentage point cut, then another quarter percentage point a couple of weeks ago. It will meet again in mid-December. Listeners might remember a few weeks ago, we mentioned that the Federal Trade Commission issued new rules that would make it easier for consumers and subscriptions and memberships and the automatic payments that usually come with them.

It's called click to cancel, and the FTC wants it to be as easy to exit those subscriptions and memberships as it is to sign up for them. Companies are no longer allowed to force you to contact a customer service agent in order to get this done, and they can't convert a free trial to a paid subscription without getting your say-so. Well, the Consumer Financial Protection Bureau says it will be enforcing that rule and plans to, quote, take action against consumer financial firms and other covered entities that violate the click-to-cancel rule. The Bureau also noted that some credit cards give users the option to block certain recurring payments. The click-to-cancel rule is supposed to go into effect about five months from now, so if you're desperate before then, there's a pro tip for you. And finally, Ana, it's time to get into the spirit of things. Not the holiday, but bankruptcy.

Ah yes, the Spirit Airlines bankruptcy. Not the holiday, but bankruptcy. Ah, yes. The Spirit Airlines bankruptcy. Low budget goes even lower. Yeah. The discount carrier announced it filed for chapter 11 bankruptcy protection. This comes after a couple of failed attempts to merge with Frontier and JetBlue. The company was dealing with a debt burden of some $3.6 billion. So here's what this means for you, courtesy of our nerdy colleagues who cover the travel industry. First, yes, your flight might be canceled. Check with the airline. Second, the airline has not said anything about further cuts in routes after axing 30 last month. And third, what happens to your free spirit frequent flyer points? Unknown at this point,

but our colleagues say you should be able to use them per usual until it's announced otherwise. Once the airline is in bankruptcy court, it's possible that program will see changes. If you have vouchers, though, those should continue to be honored. And that's it for this week's money news. We always welcome your money questions and comments. Turn to the nerds and call or text us your questions at 901-730-6373. That's 901-730-NERD or send us a voice memo at podcast at nerdwallet.com. And remember, you can follow the show on your favorite podcast app, including Spotify, Apple Podcasts, and iHeart Radio to automatically download new episodes.

Today's episode was produced by Tess and edited by Rick Vanderkneife. And here's our brief disclaimer that Sam also read earlier. We are not financial or investment advisors. This nerdy info is provided for general educational and entertainment purposes and may not apply to your specific circumstances. And with that said, until next time, turn to the nerds.