Liquidity and the Future of Prediction Markets. Bitcoin Tech Talk Issue #212

We live in a strange time. The election is set for Tuesday and there are so many conflicting reports of who’s going to win that it’s hard to cut through the noise. What’s really interesting this election is that both sides seem confident that they’re going to win. To some degree this has been the case in every presidential election, but it seems to have intensified much more this time.

By comparison, the 2000 election was very different. Though each side was confident that it would win, everyone knew the election was going to be close. This year, there are more people on both sides that think they’re going to win by a landslide. Obviously, they can’t both be right, but there are going to be more people that are more wrong. What’s going on here? How is it that so many people have such wildly different expectations? The answer seems to be information flow.

The last 4 years have seen a much bigger divide in what information gets disseminated to whom. People on the left get all their information from MSNBC, New York Times and the Huffington Post. People on the right get all their information from Fox News, New York Post and Breitbart. The increasingly partisan landscape means people only hear what they want to hear and in this case, it’s that their side not only is going to win, but win big.

The problem is that at least one side, possibly both, gets completely deluded and has a weird view of the world. This leads to more malinvestment, ultimately hurting civilization. So how do we fix this?

Polling has traditionally been viewed as the way to gather better information. The problem with polling is that there’s no motivation for people to be honest. Even a small number of dishonest actors could change the outcome dramatically in the case of an election. Assuming that dishonesty will cancel out is also unsafe.

Price is a piece of reliable information. Oil markets, for example, are obscenely complicated, but run well because of price information up and down the entire supply chain. Profit motive, or loss aversion, creates incentive for every actor to accurately price their goods and services. What’s missing in the political prediction market are good prices.

You may say that betting markets are an indicator of this information. This is true to some degree, but is only true to the extent that the market is liquid. Can a Washington insider that wants to bet millions of dollars place one on such markets? Probably not. That said, betting markets worked pretty well up until 2016 when some people noticed a weirdness in betting patterns, namely that the people on the Hillary Clinton side were betting large amounts to change the odds while the Trump bettors were betting small amounts but were more numerous. Many have speculated that these were people specifically looking to change the odds because Nate Silver was using these betting markets for his election predictions. In other words, liquidity is instrumental to accurate information from prices and we don’t have that yet. One of the main problems is that betting requires a third party and there’s a lot of regulation for those third parties to navigate.

Of course, this wouldn’t be something I talked about unless I thought there was hope. There is hope, in the form of peer-to-peer bets. If enough people participated, there would be a larger set of data from which we could get better information that’s more objective than something like polling.

Bitcoin

AJ Towns has a post about the current Bitcoin developer sentiment on how Taproot should be activated. This is the next big controversy as Taproot code has already been merged. The main issue is that many developers are still scarred from the 2017 Segwit fight which, while good for the ecosystem caused them trauma. Opinions vary according to the article, but given that Taproot doesn’t seem very controversial, and especially given that there’s no alternative proposal, I’m in favor of making this go through quickly. The main concern, of course, is precedent, but my gut feeling is that what we do this time won’t be the way a soft fork activates next time.

I’ve worked with Michael Flaxman on a Python Bitcoin library based on my course. Here is a demo of a rudimentary multisig wallet made using this library that can be completely offline. A lot of this code is stuff I wrote for my class, so if you’ve taken my class, you’ll recognize a lot of what’s there. The main additions are HD wallets, PSBT and Compact Filters (aka Neutrino).

Speaking of multisig, Nunchuk is a new multisig wallet by Hugo Nguyen. Multisig is the next frontier as it eliminates single points of failure. Caravan, Specter and Electrum are just some of the competitors and a good user interface that allows for secure, non-single-point-of-failure storage of Bitcoin will be critical as institutional investors and corporations start using Bitcoin as a reserve asset.

Speaking of custody, Jameson Lopp makes the case for why you should avoid custodians for your Bitcoin. This is an article that we should be sending to all the people buying Bitcoin now. There will be some exchange that will blow up at the end of this coming bubble and we will want to protect our friends and family from suffering loss. Good reading for newbies for certain.

River now allows users to integrate their hardware wallets. Essentially, your Bitcoin buys can be transferred directly to your hardware wallet, bypassing custody by River, or at least minimizing it. This is great as River is already pretty newbie-friendly and a hardware wallet self-custody is the obvious next step. I would really like to see a multisig integration eventually.

Economics, Engineering, Etc.

Deniz Saat has an interesting comparison of Bitcoin in terms of total trading hours. We tend to think of Bitcoin as a very young asset, but in terms of trading hours, Bitcoin compares well to the S&P500 index, which started in 1957, in terms of trading hours. Bitcoin trades 24/7, while S&P500 only trades 8 hours during workdays only, they each have about the same amount of trading hours. I’m not sure I buy that Bitcoin is therefore just as mature, but I suspect there are trading strategies that have vastly accelerated as a result of the sheer volume. Much like online poker advanced the game much faster than live poker, Bitcoin trading has advanced trading much faster than stock trading.

Nic Carter has a 12-year Bitcoin whitepaper anniversary post which is both hopeful and inspiring. He compares Bitcoin to a Cathedral, appropriate given that both are created and maintained by volunteer labor in full open view.

There’s been an uptick in CME’s Bitcoin futures. The CME Bitcoin futures are cash-settled, so it’s really only exposure to the asset than taking actual delivery, but the fact that it’s become so popular versus other futures products points to a bigger interest among hedge funds, institutions and corporations. CME futures are to corporations what GBTC is to retail investors: a toe-dip into the giant pool that is Bitcoin. Many that are trading CME futures now will be custodying their own multisig wallets eventually.

Here’s an article on the arc of history relating to Bitcoin. The article is based on the Fourth Turning, which is a way to view how generations have certain archtypes based on the generations that came before. If you’re a fan of the concept, this article gives a good argument for why Bitcoin is a fourth-turning money, or a money for the revolution part of the generation cycle.

Ripple CEO Brad Garlinghouse thinks that Coinbase’s move to focus on their mission and less on politics is bad. This is a pattern I’ve seen from Ripple, which is that they try to get any type of attention by contrasting themselves with anything Bitcoin-related. For example, they tried to make the case years ago that they were the “American” cryptocurrency and that Bitcoin was Chinese. I really wonder if this is to position themselves for the next bull market.

Binance had some documents leak that outlined its plans on dealing with regulations. The article shows just how hairy regulatory compliance can be and how expensive it is. Though many see this as Binance skirting regulations, personally, I don’t begrudge them trying to avoid weird government rules. The problem is that the regulations themselves are pretty onerous and is one of the big reasons why we don’t get much innovation in retail finance.

China is moving forward with a central bank digital currency. China is well-poised for this as everyone there is already used to WeChat and AliPay for payments. This is pretty scary from a privacy perspective, as the move is likely to make the government even more authoritarian. Citizens’ social credit scores will be used even more to restrict freedom and there’s nothing quite as restricting as the inability to buy and sell.

Speaking of which, Iran changed its laws to allow Bitcoin use. This is a move that many have been predicting for some time as they’ve been under international sanctions. It’s not a big leap from here to using Bitcoin as a reserve asset. This is probably many years away, but this could have some serious geo-political consequences.

Podcasts

My podcast this week was with mixed martial artist Kenny Florian. We talked about how he got into Bitcoin, the parallels he sees between the development of MMA and Bitcoin and what real innovation looks like.

I also talked to the Tuscon Bitcoin Podcast about how Bitcoin will change society. A lot of the interview was on my philosophy and why we have hope in a pretty depressing time.

There’s a new documentary called Digital Rush out on Bitcoin that’s about 30 minutes long that I was interviewed for. It’s meant to be an introduction to Bitcoin. This documentary is also available on Amazon Prime.

Finally, I’m going to be on a live-stream on election night with Tone Vays. This should be fun.

Once the election is over, you can focus on Bitcoin again with my books.

Fiat delenda est.