Risk Markets And Politics

Monday, July 24, 2006

Random laws and real-money market possibilities

A few weeks ago, I hinted about possible strategies available to US-based firms seeking to operate "hybrid" real-money markets. What I had in mind was the example of Sony's EverQuest and other MMORPGs where virtual game items are sold in secondary online markets for real-money. Such examples have been popular since 2001, so it's a bit surprising that they are almost never brought up in the context of prediction market legality.

One reason for this is the "catch-22" involved in establishing a viable real-money market in play-money. In the early stages, if someone wants to buy the play-money (enabling someone to sell it), they are essentially paying to play the associated game, but if you've designed a game so fun that people are willing to pay to play it, you have already solved your "liquidity" problem, and you might be able to monetize participation directly, as with monthly fees. So allowing player-traders to exchange play-money won't hurt participation, but won't by itself cause a breakthrough either.

It is useful to think of play-money markets as games however, and consider the games they are competing against for attention. Trading games (play-money prediction markets) do not substantially compete with MMORPGs. They are more likely to compete with fantasy sports leagues (which enjoy legal protection, exempting them from anti-gambling laws) and any online game that doesn't require large, contiguous demands on one's time.

Frustrated entrepreneurs that wish to run real-money markets should - so far - be encouraged by the example of Sony's Station Exchange, an in-house auction system launched in June 2005 where users can buy and sell virtual items for real money. By hosting the market and promoting trade, Sony is acknowledging that players can win or lose things of real value in the game (which, at one point at least, contained casino-like sub-games in virtual locales). Forum discussions have popped-up here and there on the legality of such arrangements.

The defense of EverQuest/StationExchange would seem to be two-fold:

1) EverQuest is a game predominately of skill: This is the crucial point, and if EQ/SE is viable in this respect, this is excellent news for non-sports real-money prediction markets. Clearly there is some element of chance in EverQuest, as there must be in markets linked to future events. Then again, it's disturbing that poker is not considered a game of skill — and this is why I'm uncertain whether HR 4411 will apply to prediction markets. (Chris Hibbert and I agree that it ought not). Again, we come back to the notion that the legality of various games is often based more on the influence of interested parties and historical vagaries than anything intrinsic to the games themselves.

2) EverQuest players don't risk real money: More precisely, their losses are capped by the participation fee, but if that's the case, what's to stop others from specifying "participation fees" as a way to get around gambling laws? Also, wouldn't it be possible for an EverQuest player to buy virtual goods only to have them looted-away or otherwise lost in the game, resulting in a more substantial real-money loss?

Someone closer to the game should be able to shed more light on these points. How EverQuest/StationExchange is treated legally could have a significant bearing on real-money prediction markets in the US, and could determine which interests cast their lots in together.

Self-interest under the guise of morality

From Gambling and Speculation, which should be on the bookshelf of anyone concerned with overcoming the obstacles to financial innovation:
In 1776 all public lotteries were consolidated in the Loterie Royale modeled on the very successful Lottery of the Roman States sponsored by the pope, and all private lotteries were outlawed. The reason given for the last step was to prevent the French from playing in the foreign lotteries, which were more attractive than their own, and thus losing foreign exchange. But one wonders if there was not another and more important reason lurking behind this act; namely, to augment the treasury's receipts at a time when the kingdom had a budget deficit of 37 million livres. (my emphasis)

Proponents of gambling prohibition will unsurprisingly claim to be serving other interests, not protecting state monopolies or otherwise limiting competition to established favorites. Typically, the cited interests are the young, the poor, compulsive gamblers — basically, those who can't take care of themselves and whose examples are used to threaten everyone with state paternalism, no matter how insignificant the problematic cases actually are, percentage-wise (and no matter how badly cause and effect may be confounded).

Very often, moral concerns have been expressed that gambling is wasteful and diverts people from more productive activities. Alongside this idea, one would formerly hear that gambling instills a poor work ethic, or encourages "idleness", or places too much emphasis on chance over providence. Even here, real interests can be masked. Although the English laws of 1699, 1826 and 1906 were claimed to help the poor, there is reason to suspect that their establishment had more to do with maintaining the status quo and keeping the poor in their place. The higher classes had more to lose, and so had less of a need for variance than the poor. The 1906 law, orginally known as a "class law", was eventually recognized as outdated and unenforceable, and was discarded in 1960 when the Betting and Gambling Act legalized betting shops in the UK.

Over here in The Colonies, the 45 year-old Wire Act is showing its age. Turning the tide against prohibition must start by defeating the Goodlatte/Leach bill in the Senate, which fortunately seems unlikely to come up for a vote this session, or be passed by 2007. Considering their numbers, the information at their disposal, and their combined talents, there is no need for online gambling, poker and prediction market enthusiasts and businesses to remain passive. It should be feasible to: 1) marshal funds from these dispersed groups, 2) model the legislature with respect to special interest contributions and voting bloc patterns using tools like opensecrets.org, and 3) contact or deploy contributions to those legislators most likely to swing relevant votes.

This framework is crude and simplistic, but it's a start. Earlier in the year, the idea of a prediction market industry group was floated, perhaps along the lines of an IGC, but not much became of it. As I suspected, a crisis might be required to spur follow-through on such a plan. There is still plenty of time.

(As a footnote, I don't mean to imply that all of politics is reducible to self-interest, nor that there is no difference between productive work and gambling.)

Sunday, July 09, 2006

You heard it here first. Well, not really...

On July 11th of last year , I observed that:
As VIX [the US equity implied volatility index] makes new multi-year lows, David Merkel at RealMoney [$] notes: "many investors have become yield hogs, and have sold puts and calls to increase income in a tough environment. This is akin to the problems that bond managers face today in their quest to find yield." Meanwhile, Brad Setser is becoming more persistent in his suggestions that the U.S. housing market and, more generally, household wealth owes much to China's trade surplus and its impact on yields. Most intriguing is Tradesport's contract on whether the yuan will be revalued by January 1st; for it seems to be tracking the VIX since the beginning of the year.
Ten days later, China nominally discarded its currency's peg to the US dollar, revaluing by 2.1%. Lo and behold, the VIX has not been lower since the day before that surprise move (which also saw the lowest level since 1993):


Why Intrade's market seemed to track the VIX leading up to the announcement is open to debate, but the following crescendo reinforces the suspicion that it wasn't a meaningless coincidence. One interpretation is that someone was using the market as opposed to expressing a subjective probability of revaluation. It might be silly to suggest that someone was using the market to hedge against another position, and only $21,000 traded in the Dec05 contract (with $111,000 in all maturities), but this would be a straightforward explanation. In any case, this is one of the more interesting prediction markets to date.

(By the way, ten year yields bottomed in June 2005, over a month before the revaluation, and right about the time gold started gaining against all currencies.)

Thanks to Intrade for providing their data.