BLOCKCHAIN PREDICTION MARKETS: WHERE THEY CAME FROM, WHY THEY MATTER & HOW TO REGULATE THOSE INVOLVED.

• Author: Dubin, Joshua D.

INTRODUCTION

On July 9, 2018, Judge Brett Kavanaugh was nominated to succeed retiring Justice Anthony Kennedy on the United States Supreme Court. (1) After three days of public hearings held in early September, (2) Mr. Kavanaugh appeared poised for confirmation to the high Court bench. Then, in an unpredictable turn of events, reports of an alleged sexual assault surfaced, (3) prompting the Senate Judiciary Committee to schedule additional hearings. (4) Political chaos ensued. (5)

Between news of the sexual assault allegation on September 16 and the decisive confirmation vote on October 5, pundits filled countless columns and hours of airtime speculating about the likelihood of Mr. Kavanaugh serving as a Supreme Court justice. In spite of this attention, and in part due to media polarization, (6) people curious about the actual probability of Mr. Kavanaugh's confirmation had few unbiased sources to consider.

Throughout this time period, there was one venture promising an impartial projection of Mr. Kavanaugh's confirmation odds on a real-time basis. Predictlt, a research initiative developed at the Victoria University of Wellington, (7) hosted a prediction market which financially incentivized individuals to correctly guess whether or not Mr. Kavanaugh would be confirmed (Predictlt Kavanaugh Market, PKM). (8) The PKM served a dual purpose as an investing platform and as an information aggregator. Because its traders were monetarily motivated to track every twist and turn in the weeks leading up to the Senate vote, the PKM provided immediate and impartial updates on the likelihood of Mr. Kavanaugh's confirmation.

The PKM logged over ten thousand comments in its nineteen-day run, (9) an indication of people's willingness to participate in a marketplace of ideas. As a means of harnessing this marketplace and channeling it towards more reliable forecasting, prediction markets have been met with great support from economists and private entities. (10) However, they have faced equally great scrutiny from regulatory agencies. (11)

While it is likely that at least a few Kavanaugh confirmation prediction markets operated illegally, (12) the Commodity Futures Trading Commission (CFTC) addressed the lawfulness of Predictifs operation in a no-action letter. (13) The CFTC recognized that Predictifs markets were not contrary to American public interest as long as they followed certain guidelines, such as limiting the number of traders in any particular contract to 5,000 and limiting each trader's investment to $850 per contract. (14) Furthermore, Predictifs exception was based, in part, "upon the facts that ... [its] proposed market for event contracts ha[d] been designed to serve academic purposes and [that] the operators w[ould] receive no compensation." (15)

The basis of CFTC prediction market jurisdiction stems from its interpretation of trades in prediction markets as swaps of commodity futures and options contracts. (16) The CFTC has recognized that prediction markets have the capacity to facilitate information discovery and therefore benefit the public; (17) nevertheless, Commission staff have indicated that these public-interest benefits only extend to contracts related to subject matters which have generally-accepted and predictable financial, commercial, or economic consequences. (18) While Supreme Court decisions may prompt secondary economic effects, whether or not a particular justice will be confirmed would fail the "economic purpose" test that the CFTC has used to determine which matters are suitable for futures trading. (19) Therefore, operation of the PKM was only permissible due to Predictifs adherence to the CFTC's no-action terms. (20)

Yet, with the development of new technologies, nefarious markets are becoming increasingly difficult to regulate. (21) Prediction market protocols are now hosted on decentralized platforms, (22) which facilitate the formation of markets that are highly resistant to censorship or third-party interference. (23) Closely watched by regulators, these decentralized prediction markets led one CFTC commissioner to publicly contemplate their appropriate regulatory treatment. (24)

This Note defends the social value produced by well-regulated prediction markets, then offers a novel approach for liability analysis in the context of markets formed using blockchain technology. After establishing the weaknesses of individual predictions and the benefits that forecasting tools can offer, Section I introduces prediction markets and explains how they generate valuable information. Section II then describes blockchain technology and the properties that make it so effective in the realm of prediction markets. Section III focuses on the regulatory environment surrounding prediction markets and considers the unique complications presented by distributed ledgers. Finally, Section IV depicts frameworks of liability analysis developed in intellectual property common law and proposes a novel application of these principals as applied to blockchain prediction markets.

1. PREDICTION MARKETS (25)

   Predicting the future is extremely challenging. (26) Economists and social scientists readily acknowledge how difficult it is to form reliable forecasts; they regularly study why people are flawed at making predictions as well as which tools effectively foster improved forecasting. (27) One such tool promising to improve forecasting accuracy is the prediction market, which offers a mechanism to incentivize information gathering and revelation. (28) By harnessing the power of the free market and channeling it towards speculation on the outcome of any definable contingency, prediction markets provide a valuable prognostic metric: market price. (29)

   1. "It Is Difficult to Predict, Especially the Future " (30)

      A prediction is an informed guess or opinion about the future. (31) Because the future is inherently unknown, predictions embody what an individual or entity believes is most likely to occur, based on available information. (32) Predictions are useful for guiding behaviors and expectations in the fields of science, (33) finance, (34) politics, (35) and more. Unfortunately, inaccurate predictions can prove counterproductive.

      Over the past fifty years, volumes of research into heuristics and biases have dispelled the notion that people are able to impartially process information on a consistent basis. (36) For example, when an individual has an interest in the result of a given event, optimism bias tends to cause that individual to believe that the desired outcome is more likely. (37) Due to this tendency to inflate the probability of desirable results, the accuracy--and forecasting utility--of interested predictions comes into question. (38)

      Even when an individual is disinterested in a given event, as soon as a belief has been formed about what is most likely to occur, the ubiquitous confirmation bias hinders consideration of counter-evidence moving forward. (39) Confirmation bias impacts every species of decision, but its implications are particularly well-illustrated in the jury selection process. (40) In selecting jurors from the venire, a lawyer's goal is to ascertain the jurors' biases, and strike those jurors most obviously prone to drawing premature unfavorable conclusions. (41) Lawyers are entitled to remove a limited number of jurors for no reason at all, (42) but have an unlimited number of challenges "for cause" to remove jurors for lack of impartiality. (43) In allowing unlimited strikes for cause, the justice system recognizes that jurors biased from the outset will be unable to reach an impartial conclusion based on the evidence presented. (44)

      Outside of the courtroom, confirmation bias may prove particularly dangerous in the digital information age. People have more access than ever before to wide-ranging and self-serving evidence, (45) while also exhibiting strong tendencies to treat that evidence selectively. (46) Though conflicting viewpoints tend not to be avoided entirely, far more time is spent considering attitude-consistent messages, particularly when the topic is deemed highly important. (47) Because these biases skew our ability to make predictions and these flawed predictions drive decision-making, society would benefit from a more reliable, accountable, and accurate forecasting device. One tool worthy of consideration is the prediction market.

   2. Putting Your Money Where Your Mouth Is, for the Good of Society: An Introduction to Prediction Markets

      Prediction markets involve collections of people speculating on the outcome of a future event. (48) These markets allow participants to trade contracts that are similar to event derivatives, where the contract price reflects the probability of a specified result. (49) Though prediction market prices are subject to certain biases, (50) "the potential for profit (and loss) creates strong incentives to search for better information" and prediction markets have a demonstrated record of successful use. (51) The range of applications is vast, including political events, financial events, science and technology events, and more. (52)

      To demonstrate the mechanics of a political prediction market, imagine a contract that specifies that President Trump will be reelected in 2020; this hypothetical contract pays out one-hundred dollars post-election if President Trump wins and zero dollars if he does not (the "Trump2020" contract). (53) If the last Trump2020 trade was for forty dollars, the implied market odds of President Trump's reelection are 40 percent. (54) Similar contracts can be formed in order to determine each Democratic candidate's likelihood of earning the Democratic Party nomination.

      Leading up to November 3, 2020, those interested in a market-based measure of the likelihood of President Trump's reelection could monitor the price of the Trump2020 contract. (55) This information is valuable because the accuracy of...