👁️"Total Information Awareness"

When prediction markets are designed to directly inform particular decisions, we call them “decision markets”

In the early 2000s we saw an explosion of interest in decision markets. We have long had speculative markets in gold, currency, pigs, and other commodities, which as a side effect do a remarkable job of aggregating information. Decision markets turn this side effect into the main effect: if you want to know more on a topic, create and subsidise betting markets on that topic to elicit more accurate estimates. With Bitcarbon Runes, we are interested in how decision markets can be used to accurately price in the harm of one ton of carbon emission.

Speculation Creates Insight

Decision markets take advantage of an effect long known in finance: speculative markets do a good job of aggregating information. In any market, if one person makes an offer to buy or sell, someone else can accept that offer if they want. In a speculative market, a person can buy or sell something today in the hope of reversing her trade later for a profit.

This doesn’t work well with quick sales of houses because the process of buying and selling a house is so expensive, but it can be profitable in “financial” markets where many people frequently buy and sell items like currency, precious medals, corporate stocks, or grain futures. And when people can trade a durable standardised commodity at a low cost, speculation becomes cheap. When speculation is cheap, all you need to succeed as a speculator is a bankroll and some method for predicting, with better than random accuracy, whether the prices will soon rise or fall. But if you find such a method and use it, it tends to become less useful.

For example, if you find that prices generally rise on weekends, you might start to buy on Fridays and sell on Mondays. Yet doing this will make the price go up less on weekends, and so you will reduce the effect you are profiting from. Once many people look for and use such methods, it becomes hard to predict if the price will rise or fall, and so hard to profit by speculating in such markets.

Speculators thus compete to find information not yet embodied in market prices—so that it becomes hard to find information that such market prices do not embody. After all, anyone who finds neglected information can profit by trading on it, and thereby reducing this neglect. This idea that speculative markets do well at aggregating information has long been studied under the label “the efficient market hypothesis,” but it is easy to be distracted by straw-man claims that such aggregation is perfect. Whatever else they disagree on, most everyone in finance agrees that such aggregation is very good. While the information-collecting abilities of speculative markets are impressive, such markets have historically only been created for other reasons, such as to allow traders to hedge risks or have fun; the information-collecting effect has so far been a side-effect.

If there is anything new in the old wave of interest in “decision markets,” it is the idea of creating and encouraging speculative markets on particular topics primarily to gain information on those topics. For example, a company that wants to know when its project will be completed can set up a market for employees and others to bet on such questions. If the current price is $20 for the asset “Pays $100 if project X completed by January 1,” that can be interpreted as an estimate of a 20% chance of completing the project by that date.

Redefining Ancient Human Quest

Decision markets is a new approach to the ancient human quest for social epistemology, which asks: who shall we believe? Or more precisely: what mechanisms shall we use to combine our varied information analysis, and opinions into useful consensus opinions, and to encourage participation?

This question goes to the heart of conflicts within climate change and the uncertainty of harm of carbon emissions.

Many of the most central and contested institutions in our societies, from religious hierarchies to courts to legislatures to peer review panels and ad hoc committees, have all been justified and contested in terms of the accuracy of the “consensus” conclusions they produce. Decision markets are making a bid to be an important part of that mix.

Forking DARPA'S Policy Analysis Market

The decision market trend started when the first known internal corporate market was created at Xanadu in 1990, but sped up greatly in 2004 when New Yorker columnist James Surowiecki published The Wisdom of Crowds, a book that was soon widely read and cited. Another impetus was the DARPA’s “Policy Analysis Market,” which suddenly burst into public view in July 2003—and was immediately cancelled.

The history of the aborted Policy Analysis Market demonstrates that the underlying “decision market” concept does not yet have much credibility with the public. The vulnerability of a market mechanism to such a political attack should not be too surprising: most familiar financial products, including stocks, insurance, futures, and options markets, were once prohibited by laws against gambling. It took a long time for the relevant industries to convince the public to see each of these products as not “just gambling.” Of course, all of these products are ways to gamble, but, because they serve useful social functions, they have become politically and morally acceptable. Similarly, decision markets can also serve an important social function, especially when applied to government policy. Unfortunately, there is no large industry yet with an interest in lobbying the public to see decision markets as more than gambling. In light of elected officials’ fear of making the same political mistake twice, the PAM experience is unlikely to be repeated anytime soon. Nevertheless, decision markets remain a potentially valuable, if still maturing, tool for analysis of complex problems. A revival of decision markets in the public sector will likely wait for a new generation of politicians, or perhaps some stunning successes with these mechanisms in the private sector. But eventually, perhaps after they have repeatedly demonstrated their superior information-producing capacities in relatively uncontroversial contexts, decision markets may yet be allowed to revolutionize how we make high-value policy decisions.