There’s always been a thin line between investing and gambling, and one firm turned the concept into a multimillion-dollar industry until the government shut it down. As number crunchers like Nate Silver become cultural touchstones, how does Intrade’s fate predict the future of how we process the world?
On a crisp Tuesday in September, primary election day in New York City, volunteers are handing out mayoral campaign flyers on the fringes of Zuccotti Park, and Laurence Lau sizes up the odds. "I don't let my ideology get in the way," he says. "You can't — that's how you lose money." On a concrete table, a spreadsheet listing candidates and prices is open on a laptop and Lau explains how his computer model once turned raw data into positions on Intrade, a now-defunct site that billed itself as "the world's leading prediction market."
"I like betting because it's the ultimate form of truth," Lau says. "If someone says something to me and won't put money on it — forget about it."
Our meeting place is famous due to its association with Occupy Wall Street, but Lau picked it because it was one his regular lunch spots when he worked inside the nearby World Financial Center. By day, as a 26-year-old mutual fund analyst, he pored over billion-dollar investments, and by night, he traded tens of thousands from his own savings on Intrade, making bets with counterparties around the world. The market's mechanics mirrored the proposition of a handshake wager: Traders bet directly against one another, winner takes all, with contracts always paying off in increments of $10. If a seller was willing to risk $6, the buyer would put up $4, and people would say the contract was "trading at 60," giving the price the appearance of a percentage probability.
Intrade's system was designed to evoke sophisticated investment, not a casino or a horse track; it rewarded analytical calculation over partisanship and wishful thinking. In theory, the traders' collective wisdom, reflected in the market's prices, would augur the ultimate electoral outcome. In 2008, for instance, it had come within one electoral vote of nailing Obama's margin of victory. Its record had won it a following among journalists, Washington insiders, and a small cadre of economists who believed in a radical-sounding proposition: that free markets could be used to reliably forecast world events.
Though Intrade was tiny, and based in Ireland for regulatory reasons, its backers included several billionaires and a passel of American hedge fund managers. The site reflected their gospel of quantification — the numerical ethic that has spread, in recent years, from the finance world to nearly every competitive facet of American life. Intrade says its users wagered a total of $230 million on the 2012 presidential campaign, which made it nothing more than a flyspeck in comparison to actual financial markets. But it attracted an avid community of traders — finance guys, card sharks, political junkies — most of them young men in their twenties, the Xbox and Red Bull demographic. They scoffed at the rubes, like the tea partiers who bet real money on Herman Cain. They competed for inside information, cozying up to political reporters and campaign workers. A few traders, the evidence suggests, employed the sort of bucket-shop tricks that might have gotten them handcuffed by the Securities and Exchange Commission if they had tried them in their day jobs. When they made a killing, the wolves of Intrade howled about it on the site's message boards, and on Twitter.
On primary nights, Lau would sometimes call county clerks to pry out the latest voting numbers, before they reached news organizations. "That's what I think a lot of Wall Street is," Lau says. "Have an edge and don't tell anyone about it."
In his wagering, Lau gave similar weight to the teachings of Paul Tudor Jones — a Wall Street legend who was an early Intrade investor — and Billy Beane, the statistically minded baseball executive who was the hero of the book and movie Moneyball. His computer system owed something to Black-Scholes, a financial model for derivatives, and something to Nate Silver, the poll-crunching star of the 2012 election, then based at the New York Times. Though Lau's winnings were modest — "five figures," he says, money he was setting aside to pay for an MBA program — he thrived on the competition, and the stories, perhaps apocryphal, of traders who had hit big jackpots. "Some other guy," he tells me, "bought a million-dollar condo in the Financial District with his winnings."
The night of the 2012 election, Lau camped out in his office adjacent to his firm's trading floor, taking advantage of the ultrafast internet connection to get an extra nanosecond's advantage over the guys using their living room Wi-Fi. Meanwhile, down in Virginia, Joe Schilling — a communications professional who drove a car with the vanity plate "BETSMRT" — was sitting in front of three computer screens, monitoring the markets for individual states, which you could also bet on Intrade. "We were buying, hand over fist, Obama-Virginia contracts in the 40s," he said, "and rode it all the way up to 100."
Along with the reelected president, new modes of quantitative analysis were vindicated by the 2012 campaign season, which sometimes seemed as much a contest between dueling statistical models as ideologies and candidates. Journalists like Silver and the Washington Post's Ezra Klein, and the Obama campaign's own sophisticated numbers operation, were hailed as avatars of a new force of rationality in media and society. The nerds won.
But Intrade wasn't given much of a chance to capitalize on the moment. Within months of the election, the company had collapsed beneath the weight of a U.S. government lawsuit and a crippling financial scandal. Some of the factors in Intrade's demise — regulatory ambiguity, erratic management, a flawed business model — were ills common to many internet startups. Other travails, including the mysterious death of its longtime CEO on Mount Everest, were like plot twists from an adventure novel. But the root source of the market's problems, defenders say, was a gap, perhaps unbridgeable, between a promising model for predicting the future, and the legality of Intrade's betting parlor.
As New Yorkers cast their ballots for mayor, Lau could do nothing but rue the wasted profit opportunities. "What is gambling? Can someone define gambling for me?" he asks. "Is it putting money on an uncertain outcome? Then that sounds like Wall Street."
In a federal lawsuit filed in Washington, D.C., the U.S. government accuses Intrade of flouting regulation and violating securities laws. The regulators contend that beneath its innovative façade, the site was really just another grubby offshore bookmaker. Koleman Strumpf, an economics professor at the University of Kansas, says the powers that be could never accept the promise of prediction markets. "It was socially unseemly," says Strumpf, who has shown that the practice of betting on elections has a long history, and an equally a persistent habit of attracting the wrath of the authorities.
Roman bookies ran numbers on the election of Renaissance popes until Gregory XIV banned the practice on penalty of excommunication. Around the turn of the 20th century, Wall Street brokers openly traded election futures and newspapers quoted their prices like modern opinion polls. Strumpf estimates that at the peak of this practice, in the election of 1916, around $10 million was bet on these markets — more than $200 million in today's dollars. By the end of the New Deal era, though, the electoral markets had all but disappeared, due to both competition — modern polling pushed the betting lines out of the newspapers — and legal crackdowns.
American law has traditionally drawn a distinction between hedging risk for an economic purpose and playing games of chance. Putting $100 on the Broncos is illegal, but speculating on the future price of a barrel of oil, or the timing of your own death (via life insurance), is perfectly acceptable. "Lots of ordinary financial things are gambling," says Robin Hanson, an economist at George Mason University. "But they are carved out in the public mind."
Hanson argues that laws against gambling suppress a useful social purpose. Economic studies have shown that point spreads, which shift with the actions of numerous bettors, are a reliable predictor of sports contests. More than two decades ago, Hanson began to wonder: Why couldn't the same mechanism work for other types of clashes, like contentious scientific debates? "I was a contrarian hanging out with a lot of other contrarians in Silicon Valley," Hanson said, describing people who were both "rabidly libertarian" and interested in exploring the internet's capacity to solve problems. "I sort of pulled those two things together," he explained, "and said how about betting markets?"
Hanson called his concept "idea futures," and devised a game where people could wager play money on questions like the chances of developing cold fusion. In a 1995 article for Wired, he wrote that he hoped the prototype would inspire real investors, with real money, to create "a radical, market-based alternative for reaching scientific consensus."
The idea ended up resonating, initially, with a different audience: the U.S. intelligence community. After Sept. 11, the Defense Advanced Research Projects Agency, or DARPA, the military's research arm, commissioned a group involving Hanson to develop a market to forecast events in the Middle East. The resulting firestorm was, perhaps, predictable. "The idea of a federal betting parlor on atrocities and terrorism is ridiculous and it's grotesque," said Sen. Ron Wyden, a Democrat from Washington. The head of DARPA, Adm. John Poindexter, was forced to resign and the project was squelched.
In a recent interview with the New Yorker, Wyden suggested that he seized on the gambling experiments as pretext to kill a more sinister surveillance program Poindexter was pursuing. But Hanson says his research was a collateral victim. "Once you have a moral principle like that," he says, "factual analysis doesn't really matter."
The logic of the marketplace has many proponents. In his popular 2004 book The Wisdom of Crowds, financial journalist James Surowiecki extolled the accuracy of collective predictions, citing the success of experiments like a rudimentary election market run out of the University of Iowa. But lawmakers have shown extraordinarily little sympathy. "We idolize Einstein and Isaac Newton," says Emile Servan-Schreiber, a prediction market pioneer who now consults on corporate applications. "The idea that the expert human mind could be outclassed by a bunch of amateurs getting together is very disturbing, as disturbing as saying the Earth is not the center of the solar system."
The irony, of course, is that even as academics struggled to establish their fledgling markets, Wall Street was conducting its own experiment, with much more dangerous stakes. In the late 1990s, Congress passed a series of laws relaxing regulations on financial derivatives. Some of them had practical applications — a utility could buy weather futures to hedge its financial exposure to a heat wave — and some proved disastrous. Infamously, bankers invented derivatives to place trillion-dollar bets on home mortgages and the risk of credit defaults, which led to the near-implosion of the world economy when the real estate bubble collapsed in 2008. But long before any of that, in 1999, some guys from the pits of New York's commodities exchange decided to start a website where you could speculate on current events.
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