Financial instruments are derivatives of underlying reality. A share of stock in Apple Inc. represents fractional ownership of Apple’s offices and intellectual property and the cash flows from its business. An Apple option represents a bet on the future price of that Apple stock. An S&P 500 index fund represents a collection of claims on 500 companies’ stocks. A Treasury bond represents a claim on the US government’s future ability to collect taxes. A Treasury futures contract represents a claim on the future delivery of a Treasury bond. Oil futures represent the future value of crude oil drilled out of the earth and delivered to certain terminals. An interest-rate swap represents a bet on the future level of some benchmark interest rate calculated from the actual rate charged in some set of lending transactions.

It is often true that the underlying reality is, in some loose sense, bigger than the financial instrument derived from it. Apple’s stock is quite big, but Apple is bigger. Its $4 trillion stock-market value represents only a fraction of the economic activity involving Apple. If you buy an iPhone for $1,000, maybe $250 of that goes to shareholders; the other $750 goes to Apple’s employees and suppliers and other stakeholders. But, also, if you buy an iPhone for $1,000, presumably it is worth more than $1,000 to you. If you use that iPhone to text your loved ones and buy stuff online and write financial newsletters, all of that activity is in a sense downstream of Apple.

More simply, when the financial instrument is a “derivative” in the technical sense — a stock option, a Treasury futures contract — the underlying market is often bigger than the derivative market. An Apple option is a side bet on Apple stock; the stock is the main event. But that is not a law of nature, and sometimes derivatives markets become bigger than the underlying markets. Intuitively, if the underlying market is smaller, then the tail will wag the dog a bit: Instead of the price of stocks determining the outcome of options trades, the options trades will determine the price of stocks. “Futures lead,” people sometimes say about the US stock market: Large-scale information about the world is first incorporated into the price of stock index futures, and then changes in the futures prices cause changes in the prices of individual stocks.

Even for individual companies, it’s not a law of nature that the company has to be bigger, in my loose sense, than the stock. Arguably the definition of a “meme stock” is that the valuation of a stock has outstripped the reality of the underlying business. At its meme-y peak, Trump Media & Technology Group Corp. did about $4 million a year of economic activity and had a stock market capitalization of $10 billion, though to be fair a lot of economic activity really is downstream of Donald Trump’s posts on Truth Social. 

Occasionally the underlying reality is quite a bit smaller than the derived financial instrument, and then weird stuff happens. Some classic cases:

• The Indian stock options market is much bigger and more liquid than the Indian stock market, so you can make a lot of money on options by pushing around the stocks. Last year India’s stock market regulator accused Jane Street Group of extracting billions of dollars of profit by doing that.
• Libor, the London interbank offered rate, used to be the main benchmark interest rate. By the 2000s, the underlying market that set the Libor benchmark was pretty quiet, and Libor was famously “the rate at which banks don't lend to each other.” Banks realized that they could make large profits on their interest-rate swap positions by changing Libor, which didn’t even require manipulating some smaller underlying market. Libor was set by calling up banks and asking them their borrowing costs, and they could just say the number they wanted to help their swaps trades. This was a huge scandal and people went to prison for it.
• Credit default swaps are derivative bets on whether a company will default on its debts. In the 2010s, people figured out that a company could “default on its debts” in a technical way that did not create too much real-world trouble for the company or its creditors. And so credit funds would go to companies and say “hey, we own a lot of CDS on your debt and we’d like to you to default, so we’ll give you some money to default and it won’t cost you anything.” The derivative bets had a lot of money at stake, and the underlying default had less reality than people thought, so there were trades to be done. This eventually stopped working; no one went to prison for it, though the Pope did weigh in.
• There was a New Jersey deli with a stock market value of $2 billion. That was real weird.

In general, the more value there is in the derivative market, and the less reality there is in the underlying thing, the easier it is to make money by market manipulation. You bet a lot of money on the derivative, and then you easily manipulate the underlying thing to make your derivative pay off.

One, uh, accomplishment of modern prediction markets is that they can, in theory, allow for an arbitrarily large amount of betting on arbitrarily small quantities of reality. You can bet on what words someone will say at a press conference, and make tens of thousands of dollars if you’re right. It is possible that Jerome Powell saying “inflation” at a press conference might have enormous economic value in the real world: He helps set interest rates, and his views on inflation can be material to the global economy. But you can have markets like this on any words said by anyone, with no particular requirement of economic materiality. Kalshi will let you bet on whether the announcer in a college football game will say the word “turf.”

And so one meta-strategy for trading on prediction markets is to try to find the largest gaps between (1) the amount of money to be made and (2) the amount of underlying reality. And then, you know. Make a big bet, and cause a small change to reality so your bet pays off.

Kalshi, for instance, offers bets on what the settlement price of front-month West Texas Intermediate crude oil futures will be today. There’s about $300,000 of volume in those bets, while billions of dollars of WTI futures trade every day. You’d have to spend billions of dollars to move the price of WTI enough to make $10,000 on your Kalshi bet. No one is going to do that.

On the other hand!

France’s weather forecasting service has filed a police complaint after detecting anomalies in its temperature gauges at Paris-Charles de Gaulle airport, which coincided with a surge in well-timed bets on prediction market Polymarket.

Météo-France filed the complaint alleging interference with its equipment after temperatures measured at the airport spiked by several degrees Celsius in the space of a few minutes on April 6 and 15. …

Polymarket uses Météo-France data recorded at Charles de Gaulle to settle wagers on the highest temperature of the day in the city. Predicting weather patterns has become a popular activity on the platform.

On April 6, one wallet made $13,990 in profit on a stake of less than $30 after betting that the temperature in Paris would hit 21C. The account, which was opened this month, bought so-called event contracts when their price suggested the probability of a payout was just 0.2 per cent.

On April 15, when the recorded temperature jumped in a few minutes from 18C to 22C before falling back, another wallet made more than $21,000 on a stake of just $119 by betting that the temperature that day would exceed 18C, at a time when the price of the contract suggested a probability of about 0.5 per cent.

On both days, trading volume on Polymarket’s “Highest temperature in Paris” market exceeded $500,000 — more than double the typical daily volume for this market.

“A hair dryer at a Paris airport broke Polymarket weather markets & made someone $34,000 richer,” tweeted Aaron Mars, though it is not clear that it was actually a hair dryer. The point is that:

1. You can make $21,000 by raising the temperature of one liter of air by 4 degrees Celsius for a few minutes, 
2. It costs much much less than $21,000 to raise the temperature of one liter of air by 4 degrees Celsius for a few minutes, and
3. Therefore someone will do it.

Polymarket argues that it is a “truth machine,” that the function of prediction markets is to help people to understand and interpret the world by giving quantifiable probabilities of future events. When you are dreaming up a prediction market from scratch, you will tend to focus on the predictive function: People’s aggregate guesses about the future, with money on the line, might better predict the future than other methods. But now prediction markets exist and are a big business, so they are not only in the business of predicting reality: They’re also in the business of changing it. If you can make money by predicting the future temperature of some sensor, the obvious trivial way to do that is to warm up the sensor. (I mean: Probably illegal! “Readings from the site are important for the safe operation of the airport”! But still.)

I have half-joked that the prediction markets should hire philosophers to help figure out how to interpret and resolve events. But as Marx says, “the philosophers have only interpreted the world, in various ways. The point, however, is to change it.” With a hair dryer!

Elsewhere: “Kalshi is suspending 3 congressional candidates for betting on their own elections.”

One model is that multimanager multi-strategy hedge funds, or “pod shops,” are essentially in the business of hiring, paying and firing hedge fund managers. The thing that a pod shop does is not so much “buy and sell stocks and bonds to make money for investors,” but rather “hire and fire portfolio managers.” The portfolio managers, sure, are in the business of buying and selling stocks and bonds to make money, and the pod shop supervises and enhances their business in various ways. But the portfolio managers are to some extent a black box, just inputs to the pod shop’s business. The portfolio managers do the portfolio managing, and the pod shop is a layer of abstraction above them.

I am probably overstating things. For instance, if a portfolio manager leaves one hedge fund to go to a different hedge fund, and she starts doing a strategy at the new fund that she did at the old fund, occasionally the old fund will sue the new one for stealing its intellectual property. That is, the strategy itself — the stocks and bonds she’s buying, and the methods she uses to buy them — is part of the old fund’s secret sauce; it belongs not solely to the portfolio manager but also to her employer.

Still, if you take seriously the idea that the pod shops are essentially in the hiring business, then you might think that their secret sauce is the hiring. The essential thing that they do, that others can’t do, that gives them their competitive advantage, that makes their founders rich, that they guard as their most precious secret, is finding portfolio managers and structuring and negotiating their pay packages.

In the real world, the way job negotiations often work is:

1. You’re happily employed at a job.
2. A competitor comes along and says “you seem great, we’d like to hire you.”
3. You very sneakily talk to the competitor while still doing your job.
4. Eventually you work out a deal with the competitor, where they will pay you 50% more than your current job pays.
5. Then you go to your current employer and say “hey, I have an offer from a competitor to pay me 50% more than you pay me, I hate to leave but.”
6. Your employer says either “so leave you traitor” or else “no, we can’t lose you, we’ll pay you 60% more.”
7. If your current employer beats the new offer, you stay.

Fine, normal.^[1] But notice that, if you’re a hedge fund portfolio manager, in Step 5 you are giving away the competitor’s secret sauce to your current employer. The competitor’s most secret and important competitive information is how it hires and pays portfolio managers, and you’re just telling your employer that! Shocking. Obviously, in Step 3, the competitor should demand that you sign a nondisclosure agreement, promising never to disclose their competitive information, such as for instance what they’re offering you.

But then you … can’t negotiate a counteroffer? Like you go to your current employer and say “I have an offer from a competitor, so I’m leaving,” and your current employer says “who?” and “how much?” and you say “I can’t tell you,” and your current employer has to guess? “Would $10 million be enough to keep you?” “Getting warmer.”

I’m mostly kidding but Bloomberg’s Chris Dolmetsch reports:

Schonfeld Strategic Advisors sued Millennium Management portfolio manager Adam Grunfeld for allegedly reneging on a deal to jump ship, claiming he owes $11 million for failing to live up to the agreement. ...

According to the suit, Grunfeld expressly agreed to pay $11 million if he backed out of the deal but has refused to do so. Schonfeld is also seeking unspecified damages for Grunfeld’s alleged confidentiality violations, claiming he engaged “in a blatant effort to leverage Schonfeld’s contractual commitments to renegotiate improved terms for himself at Millennium.”

I mean! That’s how job negotiations work? You blatantly leverage your new offer to renegotiate improved terms for yourself at your current job? Do people not do that? Anyway here’s the complaint, which supports the model that the business of a pod shop is finding the right portfolio managers:

Defendant is a highly specialized portfolio manager possessing unique investment judgment, strategy design, and capital deployment expertise developed over many years. His anticipated role at Schonfeld was specifically tailored to his individualized trading strategies, risk management approach, and performance history, which are not fungible or readily found among the pool of other professionals.

Schonfeld says that Grunfeld signed a confidentiality agreement covering “Confidential Information,” which “includes, but is not limited to …business strategies … and any other non-public information concerning the Company’s Businesses.” Schonfeld argues that he breached that agreement when he “disclosed the terms of his Employment Agreement and related negotiations to his current employer, Millennium Management LLC (“Millennium”), a direct competitor of Schonfeld.” 

I feel like it can’t really be the norm that hedge fund portfolio managers are not allowed to use one fund’s offer to negotiate a better deal from another fund. But I get why the funds might think it should be.

I wrote in 2023 about two crypto exchanges, Binance and Coinbase. Coinbase Global Inc. was a US public company, headquartered in New York, incorporated in Delaware and listed on the Nasdaq; it had an international customer base but put a lot of effort into serving US customers in a regulatory compliant way.^[2] Binance was famously located nowhere, and most of its business was an international exchange that was off-limits to US customers, though its chief compliance officer once told colleagues “we are operating as a fking unlicensed securities exchange in the USA bro.” 

At the time, US regulation of crypto was onerous and uncertain and also important, in the sense that the US has a lot of money and a lot of interest in crypto, so figuring out whether and how to serve the US market really mattered to a crypto business. Binance and Coinbase took diffferent approaches. Coinbase tried to establish itself as a good citizen, offer products that complied with US law and work with US regulators so that it could be the leader in the US market. Binance tried to manage its US regulatory risk mostly by avoiding the US and swearing over email. The US regulators clearly didn’t like crypto, so what was to be gained by trying to work with them?

I wrote about this in 2023 because the US Securities and Exchange Commission brought fairly similar and near-simultaneous lawsuits against Coinbase and Binance, accusing them of operating unlicensed securities exchanges. Two different approaches, but to the same place. Binance, it seemed to me at the time, was right to more or less give up on US regulation.

This was a decision that a lot of crypto-adjacent companies had to make, back in 2023. You could try to work with US regulators, knowing that the US regulators hated you and would be hard to work with. Or you could establish yourself in a foreign jurisdiction, declare yourself off limits to US investors, and winkingly encourage them to use VPNs to access your platform. 

The former approach — the Coinbase approach — was tedious and hard to scale; the latter approach — the Binance approach — was fun and exciting and made people rich. But the Coinbase approach was essentially a bet that, in the long run, the US would come around. US crypto regulation would be relaxed, and there would be billions of dollars to be made doing crypto in the US. But US crypto regulation wouldn’t disappear, and the billions of dollars would be made by the people who had established their US regulatory bona fides and painstakingly signed up US customers and could work with the regulators. You wanted to be one of those people, frustrating though it was in 2023.

More bluntly, the Coinbase approach was a bet that Donald Trump would win the 2024 presidential election and then the floodgates would open for crypto. This bet was correct.

Same exact analysis for prediction markets, with “Kalshi” for “Coinbase” and “Polymarket” for “Binance.” Bloomberg’s Annie Massa, Emily Nicolle, Isis Almeida and Katherine Doherty report:

Polymarket, the long-time leader in prediction market trading volume, has fallen behind its chief rival as it faces a growing list of operational stumbles in its attempt to reach a crucial audience: US customers. ...

For most of the last few years, Polymarket had more trading volume than any other prediction market exchange, and it continues to grow and attract as much attention as any player in an industry it dominates along with Kalshi Inc. Recently, though, its global trading volumes have been eclipsed by those of its main rival, according to user-compiled data on Dune Analytics. …

An anything-goes spirit pervades the prediction market space and no purveyor — including Kalshi — has been immune to growing pains, as state officials fight to shut down the exchanges in court and critics accuse them of escalating a gambling epidemic.

But while Kalshi has recently gone to pains to paint itself as a friend to regulators and big institutions, Polymarket has stood out for its willingness to buck regulatory and financial conventions. It has let customers wager on topics — like war and nuclear detonations — that its competitors and some lawmakers have said should be illegal. It has also been slower than rivals to crack down on insider trading and continues to rely on a blockchain network on its offshore exchange that allows users to operate pseudonymously.

Right, again, in 2023, it was entirely reasonable to think “prediction markets are never going to work under US regulation, so we’re going to focus abroad, ignore US rules, and winkingly encourage US traders to use VPNs.” Trying to run a prediction market under US derivatives regulation was a bummer, and doing stuff on the blockchain for an international clientele was better for volumes. But in 2026, the situation is reversed, and Kalshi has a significant first-mover advantage in the US.

Three points here:

1. It’s fine. Binance is fine, Polymarket will be fine, and the advantage of being the most upstanding regulatory citizen, in 2026, is not that great. It’s not exactly that there are no rules now, but it’s a little like that.
2. I don’t think Polymarket’s bet was bad. Nobody really expected that the US would just universally legalize sports gambling on prediction markets, which is what gave Kalshi its current edge. “The US will be a regulatory slog forever so let’s just be on the blockchain” was a reasonable thing to think.
3. That said! These are prediction markets! You know!? Kalshi could have hedged its US-is-a-slog risk by buying a bunch of “Harris Wins 2024” election contracts, which would have paid out a lot of money if the US continued to be a slog. Polymarket could have hedged its US-will-boom-without-us risk by buying a bunch of “Trump Wins 2024” election contracts, which did pay out when US prediction markets turned the corner into their golden age. (“Prediction Markets Are a Thing Now,” was my headline two days after the 2024 election.) I am generally skeptical of the idea that election contracts are a good hedge for most companies’ actual business risks, but they really would have been a great hedge for prediction markets’ business risks.

The Chicago Maroon reports:

At 1:30 p.m. on April 17, a group of undergraduate students identifying themselves as “UChicago For Our Future” gathered on the main quad, handing out onions to protest the 1958 Onion Futures Act. 

The 1958 law prohibits the trading of onion futures contracts, making the bulbs the only type of agricultural product banned from futures markets in the United States. 

To draw attention, the group brought approximately 100 raw onions to the quad in a large cart. They encouraged passersby to participate, saying that any student who ate an entire onion would be featured on their website. About 20 students attended the event, while others took onions as they passed through. The group also collected 131 signatures on a petition to repeal the law. 

I feel like you might see a protest like this at Oberlin as a joke, but at the University of Chicago market distortions are deadly serious and the protest was in earnest. Maybe:

“It’s always filled me with fury that we accept such odd minuscule policies that really are just odd market distortions,” second-year Adam Ash, a member of the group, said. “Even if one specific issue seems minute or minuscule and trivial, what matters is a combination of all of these. It’s a death by a thousand cuts to our agricultural policy.” …

The group’s Instagram account was later banned, which Ash claimed was the doing of “the corn lobby.”  

Okay maybe a joke?

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