Is Kalshi "Just Gambling"?

Thanks for having me. I'm excited.

You know, I mean, it's very similar to what, maybe I'll start with this actually. Recently I found this court opinion. It reads essentially: we're clearly of opinion that dealing in these types of markets is void by the common law for among other reasons it is contrary to public policy. It is not only contrary to public policy but is a crime, a crime against the state, a crime against the general welfare and happiness of the people, a crime against religion and morality, and a crime against all legitimate trade and business. The species of gambling has become emphatically and preeminently the national sin, is proportional to an extent it is immeasurable, and they go on and on about how horrendous this activity is. You know what's interesting about what I just read? There's an opinion from 1888, right? And it's not about sports prediction markets or prediction markets. It's about grain futures, right?

Yeah. There's an opinion that at the time was just calling grain futures gambling. And they're calling them sin. And these farmers are betting on the price of grain, and at the time society was used to thinking of these things as gambling. And why? Because you had the bucket shops that were what the modern-day casinos or sportsbooks were like, where farmers would go in and bet on the price of grain. But there was a structural difference, there was a very important structural difference between the bucket shops and the company that this lawsuit was about, which is the Chicago Board of Trade, which is now CME, the largest derivatives market on the planet, largest financial market on the planet, the most financial market of all really. And that structural difference is like: are you betting against the house, where the house sets the odds and it sets them in such a way where if you win too much, if you're a card counter, you get kicked out over time, and if you lose, they make sure you keep losing by giving you promos and incentives. It's a model that's structurally about, you know, solely about entertainment, where you're transferring wealth from people to the casino.

And that's very different from an open marketplace, an open exchange where the marketplace is a neutral place. A Chicago Board of Trade is neutral, that matches buyers and sellers that may have a disagreement of opinion. They're settling a disagreement of their opinion via trade, right? One way is to do it via debate. The other one is you trade. If you think the price should be higher, you can buy. If you think the price should be lower, you sell. And the platform itself is neutral. It's not making more or less money from the winners or losers. And there's a purpose for this. It's price discovery. You're creating a public good, which is as the market essentially negotiates, as people are buying and selling these markets, you're in real time figuring out what something is worth. At the time, it's like what is the price of grain in the fall? Then it was like the price of metals, what is the price of a stock. In the case of prediction markets, what is the price of a future event that people care about or relate to in the industry.

But when I think about Kalshi and prediction markets, it really is a financial market just broader. And one way to think about the stock market is a specific instance of a prediction market. And so I think there's a little bit of a misunderstanding. The purpose of a free market is aggregating knowledge that's dispersed and surfacing it to light. Why do people look at our political forecasts? Because they're accurate. And why are they accurate is because there's a lot of smart people that go out there in the world and they research in their labs. They run their own polls. They do all sorts of things to acquire knowledge and then they get rewarded for that knowledge by trading. And why is society rewarding them is because they're making us smart about the future. They're helping us do this price discovery mechanism. Those people are not allowed in a gambling business model. The gambling business model is not about acquiring knowledge or price discovering or anything like that. It's again about entertainment and...

They limit them, right? It's a fundamentally different model. Now obviously there's risk, so you know, speculation comes with risk and that's true for options, it's true for futures, it's true for prediction markets, but I think it's a little bit of a misunderstanding of what these markets are.

Yeah, I mean, you know, so if you're buying a market, as you said, each event contract is a share, right? It's a bit like an option. Historically, you know, the option pays out if the stock is above a certain price or below a certain price. If you have an option on stock, in this case, this option really, we call it a swap legally, but it pays out based on whether an event happens or not, you know, and pays out $1 if the event happens and zero if not. And you can buy one option or one share, you can buy a hundred of them, you can buy a thousand of them, however many you want. Now, if you're saying you want to buy 100 shares at 40 cents, right, it's a bit like you're implying that there's a 40, you think there's a 40% chance of the event happening, and so you know, you basically are putting $40 because 100 shares times 40 cents, and then somebody on the other side is selling you those shares.

So, and the way that we really think about it is like if you're buying yes at 40 cents, someone on the other side is selling you the yes at 40 cents, and it's the same as they are buying a no at 60 cents. So you're buying these 100 shares from somebody else, and that could be anyone, anyone in the open market, and you know, that's a transaction, that's a trade. When you guys match, agree on price, you have a trade, and then you know, whoever wins ends up getting the dollar effectively. Now what's interesting is most people don't actually hold it to maturity. You know, you might buy at 40% chance, but then you know, a series of events happen where the market price moves to 70 cents, and then you sell it for 30 cents profit, and you don't wait till maturity.

Well, before inflation, if the market moves, if the expectations around inflation go up, right?

You know, it's a little bit like right now with the midterms, right? Like the odds of the Republicans or Democrats winning the Senate are moving over time. People like buy low and sell high often, and they're basically trading, they're really trading it like an active market. I mean, that's what they do. And the way we make money, so you know, we just talked about like, you know, $40, $60, you know, being back to make a transaction. There's $100 that really moved of volume that just happened. We take around 70 basis points, so 0.7%. So we would be making 70 cents that we make. We basically take close to half and half from each of the part.

It's like the New York Stock Exchange. It's the exact same thing. And we're kind of indifferent to who wins or loses that whole, it's exactly how the New York Stock Exchange works.

What we want is you want more transparency and more efficiency. What markets work because we want competition. So you say, hey, like, you know, somebody says I'm willing to sell you these 100 shares at, you know, let's call it 50 cents, and you say I'm willing only to buy them 40 cents. Then somebody else comes out and competes with the first person and says, well, I'll do it at 48. And you might say, okay, I'll move to 42. Then someone else comes in and says, I'll come down to 45. And that competitive thing, that thing I just described is how markets usually work, and it's an order book. It's like people are saying I will buy at a certain price and people are saying I will sell you at a certain price, and they're all competing against each other in some sort of open auction. It's a bit like an auction. That makes the prices more efficient over time.

So foundationally, how do prediction markets or really any financial markets work is you want a very large diversity of participants which make the prices more accurate over time and the markets more efficient. Competition is what we want is more and more participants, which is, you know, more volume, more liquidity, gets those forecasts to be more accurate over time, and that's really the key foundational thing of our business. Like the reason why people trust our markets when they look at like, oh, is it predictive of the future, how does it, you know, if I want to figure out who's going to win a certain election and so on and so forth, is because they work. And the only way for them to work is I need a lot of volume, and I need a lot of volume from informed traders that are coming out and surfacing new knowledge and insight into the market. So I'm always looking for ways to attract a very large diversity of participants.

Setting up a uniform set of rules that are fair and equal across all my participants because it's a competition. I want everybody to have access to same rights and obligations. And then figuring out how to always promote more and more sophistication. People are acquiring more and more knowledge over time. That incentive just doesn't exist in a sportsbook. A sportsbook or a casino, they have one simple incentive, which is I'm going to maximize the losses of my customers because the losses of my customers are equal to my profits. That's it. It's very simple. And if somebody is too smart, I'm going to ban them. You know, the card counter always gets kicked out of the casino because, you know, they will take money from me as a sportsbook, as the house.

So that's the difference in structure that leads to different incentives. And so what do you do as a business inevitably as a sportsbook? You're going to ban the winners and then you're going to keep, you know, sending bonuses and all sorts of ways to attract losers to come back to your product. And that's, you know, some of the stuff that's created like addiction issues and all these issues that, you know, just come from a gambling business model. Whereas an exchange, you're going to promote fair, equitable rules that promote price discovery and liquidity. That's really how you kind of grow as an exchange and, you know, get more and more volume over time. So very different structures, very different incentives, which leads to different needs for regulatory structures around them. One, you need nationwide because you need a very large diversity of participants trading in an open, liquid exchange. And the other one is you need localized rules for each state to make sure the book is not tilting the balance too much against its own customers, not doing too many kind of predatory things to their customers.

There are many, many examples. I mean, you know, there's a lot more papers out there being written about this, and I love going back to Hayek because, you know, when I decided to start the company, I actually read a lot of Hayek, and I think Hayek is actually the founder of prediction markets. I think at the time he didn't really call them prediction markets, he called them information markets. And, you know, at the time he talked about how market prices are a very good way to surface information because markets incentivize people to acquire or seek knowledge and then use that knowledge to trade, and they get rewarded if they're right, if their knowledge is high quality, if that piece of information they have is high quality, and they get punished if their piece of information is bad, like, you know, and markets do a very good job at averaging all of that out.

And before getting into examples, I think there's like two foundation, like two reasons why that works. So one is skin in the game, right? And there's a very easy way to think about that. Like why is skin in the game good? Is because it's a very clean incentive towards truth.

Talk is very cheap. I think I sometimes think about prediction as a tax on... but like, if you write something on Twitter, it's completely false, what is the punishment for that, right? And the example I like to think about is like, you know, you're at Thanksgiving and you're having dinner, and you always have a relative that's so certain about everything. They're so dogmatic about every single view that they have. And then the minute you tell them like, 'Hey, how about you put $50 on this?' They get way more careful. Like there's something that happens like, 'Oh, wait. Now I will win if I'm right and I will get punished.'

It depends, right? They start saying it depends, right? And exactly. And so there's a skin in the game piece. And then the second piece, which I think is really the foundation of prediction markets, is the wisdom of the crowds. And there's something very nuanced about this, but so interesting. It's like, okay, the Federal Reserve put out a paper, it's called the one that you mentioned, it's called 'Cashing In on the Rise of Macro Markets', and what they announced, they compared the Wall Street forecasts for economic indicators against Kalshi, which is Main Street forecasts, like average people.

And the Main Street outperformed Wall Street. They do say so, it says that Main Street actually is more accurate, and it's real time, and it's distributional, so it's very useful to have. And it's so interesting because, you know, when I was deciding to start the company, I had read Tetlock, and, you know, he had done some... Philip Tetlock was an MIT professor, and I went to MIT, and he had done a bunch of analysis on like superforecasters, like who are these people that are very good at predicting the future. And, you know, he did a bunch of competitions, for example, he pit a bunch of geopolitical experts, elites, the big talking heads that have been in the field for decades, against a bunch of basically random people that like reading the news, and had them predict geopolitical events, and guess which group outperformed? The random people. And there's something like really, I would say like powerful about that because it tells us that actually domain expertise is not very relevant when it comes to figuring out what lies ahead.

What's relevant is the skill of forecasting, which is self-calibration. It's thinking critically about the world, it's, you know, being in the business of seeking knowledge and being in the business of actually caring more about being right than like sounding right or ideology. Right. And I think oftentimes the experts are a bit too ideological. This is unburdened by ideology.

Exactly. In some way like the markets reduce the ideological burden that people usually have because you have to be right. You know, like when I did my master's at MIT, you know, the joke in research circles has always been like, you know, that working in Wall Street and working in academia is mostly the same thing. You have to do the research, except that in Wall Street you have to be right because you have to make money.

But really kind of the thing that's exciting about this is that like we now have like a hive mind, a critical mass of people that we can ask any question and they will surface a very large diversity of information. It goes back to diversity of people is extremely critical for this market because everyone may have different opinions and insights and bits and pieces of information and you have to average out as much as possible. So you cannot localize to just DC. If we just run a prediction market that just like, let's call it like decision makers in DC will weigh in, and they'll be less accurate than if you bring in, you know, someone in California and someone in Texas and someone in Hawaii. It is presupposed on that. That's the only way the prediction markets work.

You know, we saw there's a paper recently on the weather. So I forgot which university compared our weather forecast to like the blended average, so the max of all the kind of weather forecasts across the nation, and our weather forecasts were 10% more accurate. I mean, it's pretty amazing. And how is that possible? Well, it's possible because these users are like doing all sorts of new ways to figure out how to improve the incentive for profit pushes them to kind of push their boundaries on how could we model the weather and how could we think about it more critically, which increases our knowledge about weather patterns and like how our understanding of weather and so on and so forth. This is happening in politics, economics, and...

That's like the spill. So it's a... so that's, I go back to price discovery, right? When you look at how the commodities markets kind of got regulated and got started, the foundation was price discovery, is figuring out what something is worth, right? And at the time it was farmers, right? It was farmers thinking like, how much should I invest in my crops right now? And I don't know, and I'm not sure how much I could sell it in the fall because it's going to take me six months to, you know, harvest, and then, you know, I have no idea what the price is going to be because prices are moving all the time.

And so the futures market on the commodities, on grain and others, started because farmers wanted to have more predictability. They wanted to figure out, okay, this is the forecast from the futures market and what it's going to be in September. So that will help me inform my decisions today, right? And then that has gotten more broad, right? We move into metals and oils, and then it moves into like the banking sector, and we started like having commodities or derivatives markets about a much wider set of things that are important to price.

What prediction markets do is they generalize that concept. They just take it from all these different things and add more and more different types of markets and questions that are worthy of being forecasted, being, you know, price discovered. And, you know, when you look at Kalshi today, 75 to 80% of our customers, they don't trade, the active customers, they use it as a newsfeed. They use it to get informed by all sorts of things: what is the price of diesel going to be, what is it going to rain tomorrow or not, where is this home, like is my home team going to win or not. I mean, one of the biggest sources of sort of like predictions we see like around elections and sports, it's very simple things because think about it the same way as the farmers making the business decisions of what they should do.

Bars in New York are basically deciding how much to stock up on inventory before the game because if they win, they know that they usually sell, you know, three or four times more than when they lose. And so that has a very immediate economic impact on how much they should actually stock up on inventory because, you know, you never want to be in a place where you're at a bar and like you don't have enough beer when the team wins, like, you know, who would ever go back to that bar. But think about that in a much broader scale when it thinks about weather, when it thinks about bills passing or not.

When we think about this idea of pricing risk and pricing economic questions more effectively, it's in some ways crucial to our resource allocation and decision-making over time. We're not going to be able to make good decisions if we don't have a good gauge on where the future is going to land on things that matter to us. And I think prediction markets do an incredible job at basically fitting that function, and that's why people use them. Like right now in politics, for example, most campaigns essentially use our markets religiously. Why? Because they are more accurate and they are real time and they're very, very useful.

100%.

For sure. Because what you just described is the very definition of hedging. It's exactly how hedging was defined for any commodity futures for the very existence of the Chicago Board of Trade and Chicago Mercantile Exchange, the CME. It's this idea that like you have some risk that is tied to something you don't really control and you buy a position that offsets some of that risk. Oftentimes people, you know, some people do, you know, they want to offset the whole risk. Some of them they want to offset some of the risk, right? What Kalshi is doing is essentially pricing a broader set of risks. It's not just about what the price of grain is or what the price of oil is going to be. It's about what the price of all these different risks that we're exposed to, and then you can buy offsetting positions.

Some people will buy to speculate, they want to increase their exposure to an event, but a lot of people basically do it to reduce their exposure to an event because they have calculated some kind of exposure they're going to be hit by if an event goes one way or the other, right? And I think our function, when I was at Goldman, I thought about it, it's like, well, yeah, if you're a big corporation like a Fortune 500, you can, you know, pick up the phone and call, you know, my boss's boss at Goldman so that we can structure a product for them. But if you're an average business or an individual, you don't have access to any of these products, right?

And I think this idea that you can actually shield yourself against some of the volatility that you don't exactly control is very, very important for business and individuals because what businesses need most is predictability, right? Businesses with very unpredictable cash flows usually get valued less than businesses with predictable cash flows. Why? Because if you have predictability, you know how to invest, you can raise more money, you can just prepare for the future better, right? And so that's what we're bringing at the core. We're bringing that notion of risk hedging to a much larger number of businesses and individuals.

And, you know, I love the sports market because, you know, people are really trying to create a bifurcation between sports. Okay, economics and weather markets are fine, but sports is not fine. But I always find it interesting because based on the exact same structure, there are people speculating on economics or on weather or on politics or on financial market prices, and they're speculating on sports, that exists across the board, and there are people hedging across all of them as well. And the structure that I just described on how these markets work is the same. The structure doesn't change. The topic could change. It could be sports, weather, climate, whatever. But the structure is not changing. It's the same exact structure.

And to me, this idea that sports doesn't have economic consequence or elections don't have economic consequence is ludicrous, right? Like where FIFA, where FIFA is going to be played and whether America... I mean, when the FIFA World Cup was happening, you know, advertisers were talking to us a lot about looking at the odds of the US making it, plus...

And if the US loses, the viewership...

Basically, the dollar value of your advertising slot essentially gets halved immediately, purely based on that loss. You can make those arguments about, you know, marketers backing certain players. You know, the one I always like to go to is the sports bar, because it's something that's so understandable and tangible to people. People get it, right? Like, sports bars do a lot of hedging on cash against their home team losing for the same exact reason. Like, they make $2,000 on a night if the team wins, and if the team loses, they make $800 on sales, but the cost is usually the same. They stock up on inventory and they do 1,200. So in one night, if they win, they're up 800, and if they lose, they're down 400. So what do they do? They take an offsetting position. They buy 'no' on the team winning, on their home team winning. So they short their home team so that if they lose on their business, the revenue loss is offset at least partially with the hedge, the insurance.

They usually smooth it out perfectly. They end up being a place where they're plus 300 no matter what, and that's better for them than the volatility. They have less exposure and they can invest more decisively, which is a great outcome, and that's why hedging is so important.

Certainly. Yeah.

I mean, look, I think I'm also, you know, I believe in free markets, and I think, you know, if you think about it, it goes back. So the Illinois opinion was a very interesting one. I mean, you know, the TL;DR is like, well, these markets are swaps. It's the same structure as anything else. It promotes price discovery in the same way, it's structured as a financial exchange. There's no difference whatsoever. Some of them just happen to be fun, and it's literally what you said, like nothing presupposes in financial markets that, like, you know, some people do. Do you believe that people trade zero-day expiry options for fun on Robinhood or on any of the other platforms?

Yeah.

Does that mean we should regulate as gambling?

Like, it's the same exact... I mean, what is the line? There's no limiting principle, there's no sound basis in the law. And the interesting thing, so I go back to history, because when the Chicago Board of Trade gets enacted, the same number of, close to the same number of states was actually suing the Chicago Board of Trade saying this is illegal gambling.

Chicago Board of Trade is the biggest gambling house in the US, exactly. So the notion that sports prediction markets are not like it, this idea that derivatives or financial markets have never been considered to be gambling or there's some clear line in our heads is not true, right? Like, all these markets have been considered gambling at a certain point, right? So how do you differentiate? How do you, like, what is the structural thing? The interesting thing about the Commodity Exchange Act, so our law, like the thing, the statute under which the CFTC operates and Commodity Futures operate, when you look at it, the history, it was enacted for the very purpose of preempting state gaming laws and state insurance laws. So when states come and say this cannot possibly be, because the CEA cannot possibly be preempting state gaming laws, it's a bit historical, because the very purpose of the statute was to preempt state gaming laws. Why? Because pretty much most of the things that were traded on financial exchanges and are still traded on financial exchanges have at some points been considered and viewed as gambling because of the act of speculation. So the line is very clear again: are you in an open marketplace that has a public good where you're promoting price discovery and it's a competitive order book, or are you betting against the house? Where, you know, so there's bucket shops, casinos, bucket shops from 100 years ago, casinos, sportsbooks from today's, Chicago Board of Trade, NASDAQ, CBOE, and that structural difference is the key piece. And here you could be speculating, you could be hedging, and the public good is the price discovery that comes out of these markets, and the prices are set by the market. That's the key thing: supply and demand, open, free supply and demand is the thing that's setting prices.

And sure, some people now are claiming that they want to carve out sports because they think that's a big market, but there's no principled way to carve it out. And the law is actually structured in a way to kind of help these markets evolve as the economy evolves. And sports now is a massive economy. I mean, private equity put $70 billion into sports in the last few years. You know, the NIL bill just passed the Senate. Like, this notion that there's big dollars and big money in sports, and there's, you know, these athletes being paid these big dollars, and cities are, you know, like, you know, when the Knicks won in New York, you know, Mayor Adams put out a press release about how this had like a $200 million economic impact on the city. I think that's a bit of an underestimate, actually. That's real, that's real economic, tangible impact. And so as you think about this industry becoming an asset class, what do you do with asset classes? You create financial products that are layered on top of that. And sure, some people are doing it for fun, but that doesn't change or negate the fact they're financial instruments and they're swaps. And nothing in the law, actually, the law is very clear. They said if something, if a swap relates to gaming, which you could argue that sports is a game, the CFTC has authority to decide what to do with it. And it's very simple, it's very written in no uncertain terms, basically.

They have to, otherwise it wouldn't work, right?

That's right.

I go back to thinking, like, this notion that sports has no economic consequence. I mean...

No, but this is my answer, right? Like, I'm kind of reasoning through sort of in a principled way, right? Like, okay, do you believe weather markets have economic consequence?

Sure. So we should have them traded. We should have derivatives on those weather markets. Do sports outcomes have economic consequence?

Of course. If you wish to have the derivatives markets on the sporting...

But my point is, so there is, in and of itself, those markets are valuable equally as much as a bunch of other markets are valuable, right? And when I look at how much hedging is happening on Kalshi every week, close to 60 or 70% of the hedges that get placed are on sports. The risk mitigating, the very purpose of these markets, is on sports. So it should show us that actually, yes, maybe speculation is 60%, 70% of the volume, and that's going down over time, but the hedging is as well. So there's no, again, there's no structural difference between those two, except that it's big business and people have historically thought about, oh, there's DraftKings and FanDuel in their sports betting, so there's a bit of that analogy that's being created, that superficial analogy that's being created in people's heads. But then, yeah, I agree with you, the two and three is like one, like you need a critical mass of customers, and sports are a very good way to educate customers about how this works. And you're seeing it, like, now with the growth of sports, we have 30 million customers in America, and that helps us, like, actually promote liquidity. And now if I want to market on, like, where will AI evolve, or will there be job displacements, like, how much job displacement is going to happen from AI in the next 10 years, I can do it in a way I couldn't a year or two ago because I didn't have enough customers, I didn't have enough liquidity. And with these markets, liquidity begets liquidity. You need liquidity that, you know, participants in a bunch of different things, that begets participation in a bunch of different things. So I don't think prediction markets exist, really, if you start carving out one or the other. And then there's a question of, like, why should it be state versus federal? Like, why are financial exchanges regulated by the federal government rather than the states? And it's a very simple thing, again, if you're creating a competition and you need a very large pool of customers, you want uniform rules across those customers, right? And then the other thing I like, that's the easiest way to kind of really think about it, is imagine we break down the New York Stock Exchange state by state. So if you're in New York, you can only buy Apple stock from New Yorkers. What would that do? It would bifurcate liquidity.