Welcome to The Nonlinear Library, where we use Text-to-Speech software to convert the best writing from the Rationalist and EA communities into audio. This is: Prediction Markets: When Do They Work?, published by Zvi on the AI Alignment Forum. Epistemic Status: Resident Expert I’m a little late on this, which was an old promise to Robin Hanson (not that he asked for it). I was motivated to deal with this again by the launch of Augur (REP), the crypto prediction market token. And by the crypto prediction market token, I mean the empty shell of a potential future prediction market token; what they have now is pretty terrible but in crypto world that is occasionally good for a $300 million market cap. This is, for now, one of those occasions. The biggest market there, by far, is on whether Ether will trade above $500 at the end of the year. This is an interesting market because Augur bets are made in Ether. So even though the market (as of last time I checked) says it’s 74% percent to be trading above $500 and it’s currently $480 (it’s currently Thursday on July 26, and I’m not going to go back and keep updating these numbers). When I first saw this the market was at 63%, which seemed to me like a complete steal. Now it’s at 74%, which seems more reasonable, which means the first ‘official DWATV trading tip’ will have to wait. A shame! A better way to ask this question, given how close the price is to $500 now, is what the ratio of ‘given Ether is above $500 what does it cost’ to ‘given Ether is below $500 what does it cost’ should be. A three to one ratio seems plausible? The weakness (or twist) on markets this implies applies to prediction markets generally. If you bet on an event that is correlated with the currency you’re betting in, the fair price can be very different from the true probability. It doesn’t have to be price based – think about betting on an election between a hard money candidate and one who will print money, or a prediction on a nuclear war. If I bet on a nuclear war, and win, how exactly am I getting paid? Robin Hanson, Eliezer Yudkowsky and Scott Sumner are big advocates of prediction markets. In theory, so am I. Prediction markets are a wonderful thing. By giving people a monetary incentive to solve problems and share information, we can learn probabilities (what will GDP be next year?) and conditional probabilities (what will GDP be next year if we pass this tax cut bill?) and use the answers to make the best decision. This method of making decisions is called futarchy. Formally, a prediction market allows participants to buy and sell contracts. Those contracts then pay out a variable amount of money. Typically this is either binary (will Donald Trump be elected president?), paying out 100 if the event happens and 0 if it doesn’t, or they are continuous (how many electoral college votes will Donald Trump get?) and pay proportionally to the answer. Sometimes there are special cases where the market is void and all transactions are undone, at other times strange cases have special logic to determine the payout level. There are three types of prediction markets that have gotten non-zero traction. The first is politics. There are markets at PredictIt and BetFair and Pinnacle Sports, and there used to be relatively deep markets at InTrade. These markets matter enough to get talked about and attract some money when they involve major events like presidential elections, but tend to be quite pathetic for anything less than that. The second is economics. There are lots of stocks and futures and options and other such products available for purchase. Futures markets in particular are prediction markets. They don’t call themselves prediction markets, but that is one of the things they are, and the information they reveal is invaluable. It’s even sometimes used to make decisions. The third is sports. Most televised sporting events have bookmakers offering odds and taking bets. They use their own terminology for m...