A new social network launched this week aiming to provide a platform “for America to once again become a nation ‘of the people and by the people’.” To facilitate this goal, the Daylight Network offers three features:
- Tracking government spending
- Participating in prediction markets on government decisions and policies (a service powered by Inkling Markets) with the end goal of influencing policymakers
- Connecting with like-minded individuals to discuss government activities and propose alternatives
Features 1 and 3 are traditional government watchdog/social networking offerings, but let’s look at Feature 2. The Daylight Foundation incentivizing thoughtful participation in their prediction markets by providing (fake) trading currency to each trader, and paying out the winning traders with (real) cash prizes.
Many of the trades offered are similar to those found on sites like Hubdub and Intrade, such as estimating the final size of the stimulus package and predicting whether a given cabinet nominee will be confirmed. These prediction results are interesting, but are of limited value to the site’s mission as they have no influence on the actual events themselves.
One market within the site aims higher. Clearly drawing upon the futarchy theory of Robin Hanson (which receives no mention), this market breaks down the Senate stimulus package line-by-line and asks users to rate the provisions from 1 to 5 stars. As we’ve discussed before, in futarchy voters don’t vote on which policies they want (as in a referendum), but rather on which policies they believe are most likely to increase national welfare.
This is where the Senate stimulus package prediction market falls short. The crude formula identified by the Daylight Network is: “create jobs, minimize the impact on the federal debt, and promote fairness to all taxpayers.” Of these three variables, the first is clear and measurable, the second is measurable but less valuable (after all, this is a spending plan and a hit to the federal debt is a given, so the results should really be the focus), while the third is totally incomprehensible (how does one spend to promote fairness TO everyone?) Together, they become an impossible muddle of a standard to evaluate proposed policies against.
With enough users, the site hopes to gain enough momentum to influence the Senate’s deliberations. Unfortunately, by failing to clearly identify the future state that bettors should evaluate each line item against, the market is just collecting a list of voter favorites and least favorites rather than a collective impartial judgment of which items will most likely contribute towards reaching that future desired state. Still, the site is an effective forum to engage voters in talking about these issues and systematically capture their opinions.
Barney Frank, Chairman of the House Financial Service Committee, told the Financial Times today that he will introduce a bill to establish a licensing and regulatory framework for online betting operators. Under Frank’s proposal, the Unlawful Internet Gambling Enforcement Act of 2006, the law that forced Tradesports to shut down and currently threatens all online sites where real money is exchanged, would be relaxed.
This is good news for prediction markets. Less regulation means that more prediction markets can operate with the component that market theory says is so important: financial incentive. Tradesports and IEM are so effective now in their predictive power because betters have real money at stake. SimExchange, Hollywood Stock Exchange, and others use a variety of other incentive mechanisms including public leaderboards, faux currency, and bragging rights, but none of these equal the power of cash.
This is also good news for those interested in freedom and commonsense policy. Barney rightly compares the stringent gambling penalties to those encountered during the age of prohibition. And if Maryland is going to grant waivers for slot machines, then doesn’t it make sense to allow betting that actually involves some brainpower and might influence decision making around something of consequence?
Kiva, the first p2p micro-lending website, is opening its doors to third party developers. Build.kiva.org is its new destination for developers looking to expand its micro-lending platform. Its blog explains:
Our website has already done so much to connect people and bring new opportunity to the developing world, but it is nothing compared to the impact we think that technology and microfinance together will have to alleviate poverty. It is going to take a lot of innovation, a lot of creativity, and a lot of passionate people bringing the opportunity of loans to places they’ve never been.
By opening up its data and enabling independent, inspired developers to create applications, Kiva hopes to further connect its community and expand its reach. This move shows that the non-profit continues to be a model of both innovation and transparency.
It’s a phrase to make you shiver: state capitalism. Yet HBR has named the re-emergence of state controlled enterprises as one of its “cutting edge business ideas” for the coming year.
Unfortunately none of the innovative markets that we profile here made the cut. Instead, HBR focuses on where the real money lies: government expenditures. The U.S. auto and financial bailouts are just small one piece of an increasing worldwide trend towards nationalization. As the article profiles, the largest companies in the critical sectors of telecommunications, energy, and asset management dwarf their purely private sector counterparts. The authors correctly note the risk to free markets of state-owned enterprises, specifically:
The (often authoritarian) governments that are profiting from these enterprises will be tempted to take foreign-policy gambles, confident that their market clout in critical sectors will limit the response of concerned countries.
I would add another concern: Will innovation continue to thrive when governments hold leading positions in so many sectors of importance? [See David Brooks of the New York Times for a thoughtful consideration of the people who are now making many business decisions.]
Government involvement in these sectors is not new or particularly “breakthrough” (Russia and China being obvious examples), but the extraordinary scale is. P2p lending, p2p e-commerce and locavesting are tiny free market and independent counterweights to this behemoth of government direction in market affairs. Will their appeal find new ground with those troubled by this opaque anti-market trend? Or will they simply be swallowed up?
For a microfinance argument for “thinking small” in response to the global financial crisis, see Elisabeth Rhyne’s article in the New York Times. The managing director of the Center for Financial Inclusion at Accion International, Ms. Rhyne argues that the traditional relationship banking practices of microfinance institutions offer a refreshing alternative to the opaque banking practices criticized in the G-20 report presented at this year’s World Economic Forum in Davos.
The characteristics of the microfinance model are appealing:
- Character-based lending
- Stepped lending, where prompt repayment is rewarded with gradually larger loans
- Group lending, where borrowers cross-guarantee each others’ loans
- Loan approval based assessment of a customer’s ability to repay from existing income rather than speculated future asset value
Even more encouraging is that this model can result in a powerful and resilient portfolio of loans while maintaining social awareness. Lenders can have faith in their investment returns while contributing towards what Rhyne terms a “distributed global banking grid” with many nodes and fewer single points of failure.
Flickr credit: herval
Legislation hastily passed by an overzealous Congress regarding children’s product safety threatens to shutter the vitality of a large portion of the p2p e-commerce community. The Consumer Product Safety Improvement Act (CPSIA) requires all manufacturers who create items for children 12 and under to submit their products for individual testing for safety.
The law is a response to the Chinese lead in toy fiasco, but it also means that the seventeen year old girl who knits custom-made kids’ hats for sale on Etsy now needs to submit her $10 “product” for testing. For small scale crafters and traders, the thousands of dollars required for testing will simply put them out of business. [Never mind the VAST waste the law will induce by requiring EVERY toy on the shelves to be pulled and tested or else thrown into the landfill]. For more on the effects that Congress failed to foresee, see HERE and HERE.
Today crafters at Etsy and other markets are hosting a CPSIA Blog-In. We lend our support.
Image credit: CK Photography
Especially due to Intrade’s wild success during the 2004 and 2008 election seasons, the major prediction exchanges have received a lot of hype and most people [interested in this sort of thing] generally know the big ones: Intrade, Hubdub, IEM, etc.
There are some intriguing and less well known ideas out there (some in practice and others theoretical) that utilize the concept of prediction markets. We will profile these occasionally [Let us know if you have ideas]. Here is the first installation.
A concept of government-by-prediction-market proposed by economist/philosopher/rationalist Dr. Robin Hanson where individuals would “vote on values but bet on beliefs”. The term itself got some attention following its selection as a New York Times buzzword of 2008 (never mind that it was first proposed by Hanson in 2000).
The gist is the legislators define a measurement of national welfare and then voters bet on the policies that they believe are most likely to raise national welfare according to the definition. This form of government disentangles values (which we can’t do much to change) from beliefs (which are too often biased by our values). By attaching a real incentive to predicting whether a certain policy will in fact increase national welfare, futarchy uses the information aggregation and bias reducing power of prediction markets.
To be clear, this concept is very different than government-by-referendum. Individuals do not vote on which policies they like or want but rather those that they would be willing to place money on to exceed a precisely defined measurement of national welfare. The main challenge to me seems to be how to define national welfare and whether legislators would be able to agree on a formula.
GDP would be a natural component of such a formula (due to its high correlation with so many signs of positive “national welfare”), but many other possible variables may be contentious (increased income equality? Increased diversity?). Defining a national welfare formula would ignite a fierce partisan debate that gets to the heart of the question of values. The concept of futarchy takes that into account; that is why we vote on values (i.e., we elect politicians whose most closely resemble our own). But then, we don’t ascribe too much confidence to the politicians’ ability to get things done to best advance our values; that is why we bet on beliefs (i.e., bet money in a prediction market on policies that will most raise national welfare as defined by the politicians we voted for). The “wisdom of crowds” should lead to the best policies…of course, if you lost the politician vote, then you won’t agree with the national welfare formula and then I suppose you either choose to sit out the betting round out or else bet money the wrong way in the hope of distorting the results.
Futarchy is only a theoretical concept at present and has yet to be tried in practice, although Dr. Hanson stands ready to assist any government willing to give it a try.
Alternative markets are being tra markets and the government is going to treat them as such. The prediction market Tradesports is now permanently shut down due to gambling laws, p2p lending market Prosper will be off-line for months dealing with the SEC, and the viability of craftsmen on Etsy and many other direct seller-consumer markets is threatened by legislation soon coming into effect and more legislation to come. What does this all mean?
Perhaps most importantly, the previous sky-is-the-limit land of innovation in markets is retracting. It took them some time to get started, but government lawyers are hard at work writing cease-and-desist letters and new laws that may spell doom for smaller or newer entrepreneurs in this field. Ventures that survived by operating in gray areas slightly out of reach of the regulators will find that they can hide no longer.
Government involvement in a sphere that was a demonstration of nearly pure capitalism is both regrettable and necessary. The consensus that regulatory and policy failure contributed towards the current financial crisis and allowed the likes of Bernard Madoff to flourish required the SEC to explore hidden markets and register all sellers of securities. Recent tainted milk and leaded toy scandals in China naturally lead the government to require higher product standards for children’s products and cosmetics.
Unfortunately for Prosper and other p2p lenders, the SEC’s actions have the most profound and immediate impact upon them, as they need to shut down (Lending Club is still open) while they spend hundreds of thousands of dollars to go through the bureaucratic process of licensing with the SEC (this is a lot of work for an organization whose average loan in 2008 was $6,047).
For small sellers of cosmetics and other homemade items, January may prove to be their last month in business as they are the forced to prove the safety of their items as dictated by the Consumer Product Safety Improvement Act (CPSIA) and the FDA Globalization Act of 2008. Due to immoral practices of Chinese manufacturers, small businesses will now need to spend thousands of dollars a year in paperwork in order to prove that their $2 homemade soaps do not contain high lead concentrations. Paradoxically, the large toy corporations who practice the outsoucing that is so feared by some American consumers will be most able to comply with the new regulations while the small crafters who make items at home using organic wool will be out of luck. The reaction by the Etsy community makes clear that many crafters will simply be forced to close down shop.
It was probably only a matter of time from the beginning for Tradesports. Their entire business model was based upon skirting gambling laws through technical operation out of Ireland, although the majority of their trades knowingly took place in the U.S. It will be interesting to see whether its non-sports affiliated site Intrade (the more innovative and interesting market I would argue) will last.
As many of the best entrepreneurial teams pushed ahead over the past several years with their alternative, and often quite persuasive, ideas, many free market enthusiasts (like myself) found it hard not to get swept up in the excitement and see these as the undenaiable future. Expectations are now revised down from their initial irrational exuberance. These upstarts have a number of hoops yet to pass through, but their promise is still bright.
An interesting factor common to many of the new alternative markets is the element of simplification: fewer steps per transaction, smaller dollar sums exchanged, and the reduced role of the middleman. To advocates, these characteristics are symbols of transparency, greater citizen engagement in the process, and a sustainable and informed approach to financial decisions. To others, the simplicity is a negative; the transactions are nearly medieval in their marketplace structure, the systems are inefficient, and there is no possibility of scale to make them true viable alternative financial constructs.
The origin of peer-to-peer lending is indeed older than medieval; Prosper’s website marks its advent as 300 AD in China. We have made vast progress since then in terms of efficiency and scale, and it is really only with the possibility of the internet and the growth of social networking that we find a renewal of this simple form of direct lending. Unexpectedly, the latest technological advances have enabled us to draw upon and revive ancient financial practices. Direct lending allows people who have otherwise been shut out of the complex credit market due to factors sometimes out of their control to turn to the old and trusted practice of asking the people around you to lend you a buck. Only now, the “people around you” are the millions on the internet.
Lending to a self-professed “entrepreneur” half way across the country (or world) is not quite the same as lending to your cousin, but these days, just knowing the destination of your money is a significant move towards transparency and accountability. But with this level of engagement in every single transaction you make, it’s true that the possibility of scale is lost. Evaluating potential borrowers on Prosper or Lending Club and then monitoring each loan you choose to make is a lot of work. The sums are small (maximum investment on Prosper is $25,000 and the default rates are high (on Prosper, 20%). Unless you are working with a small sum of money, alternative markets in their current form can only be utilized as an interesting and supplementary subset of any financial strategy.
Peer-to-Peer lending markets, local stock exchanges, prediction markets, direct buyer-seller community markets…Innovative re-inventions of the traditional marketplace, all made possible by web technology.
While the current financial crisis shakes the confidence of many free market believers, there glows a series of alternative market movements still enthusiastically embracing the core market essentials. These markets connect buyer to seller while rejecting the opacity and complication that characterizes much of our current financial framework. Their missions are generally simple and focused, encouraging participants to be knowledgeable of the market dynamics, with the end goal of fair and efficient trades between individuals and better information. These alternative markets can be classified into four major types:
Peer-to-Peer (aka Social) Lending Markets. This concept is a type of financial transaction where two parties can enter into a borrowing/lending agreement without the intermediation of a traditional financial services provider. See: Prosper, Lending Club, Kiva.
Prediction Markets. With the marketplace able to tap into the “wisdom of crowds”, prediction markets have emerged as a venue for speculating about the future. See: Intrade, Betfair, Futarchy.
Community Markets.These sites allow buyers to get to know and interact with their sellers and buy from them directly. See: Etsy.
Local Markets. As the stock marketplace has moved increasingly global over the years, local investing enables individuals to instead invest in community companies that they know and trust. See: Locavesting.
Utilizing the efficiency of the market for the traditional purpose of exchanging goods, services, and information, these emerging concepts spin the concept to meet their niche purposes. The rise of alternative markets indicates some interesting trends of our society that have implications well beyond the marketplace.
First, there is a clear desire by market participants to introduce a level of transparency in financial dealings. Each of the social lending services works on a peer-to-peer basis, so you as an individual loaner know who is receiving your loan. This is a very different operating model than giving your money to a black box financial services company that makes decisions on your behalf. As we have seen, that model does not always make the decisions that are in the best interest of the lender. Similarly, with locavesting, rather than invest in a large corporation where you have no insights into its inner dealings (e.g., Enron, Worldcom, Global Crossing), you can invest in a neighborhood store or local company where you may actually know the management, see the customers, and build a more rounded perspective of the entity’s value.
This leads to a second trend, a lack of faith in experts. Recent events point to the danger of trusting an individual (e.g., Bernie Madoff) while past events warn of ascribing too much faith to a group (e.g., the whiz kids of Long Term Capital Management). With economic experts and pundits of all stripes constantly pontificating their chosen strategies and predictions, it is hard to sort through the noise. This challenge was perhaps best illustrated during the November election when news agencies released daily polls accompanied by salient expert analysis that were often contradictory, repetitive, or incoherent. One of the best and simplest resources to get to the bottom of the single question, “Who will win in November?” was the prediction market Intrade, which harnessed the collective knowledge of its users to produce a startling accurate prediction of the final results (prediction of Democrats-Republicans 365-173 versus actual results of 364-174). The concept of futarchy takes faith in this concept a step further and suggests that prediction markets can be used to guide public policy decisions. Social lending services also indicate a desire for individuals to take control of their financial decisions rather than relying on the recommendations of experts. There you can manage the risk, evaluating potential lenders (or investments) yourself.
While alternative market participants personally gain from increased transparency and better informed decisions, all of the markets also demonstrate a commitment to building a community. Some peer-to-peer lending service operate under a “family and friends” model and all of them stress that the investment is not just a personal investment for return, but also a way to help fellow market community members achieve their financial objectives. Similarly, the direct artist-consumer model integrates social networking to make purchases more of an experience where you can get to know the person you choose to buy from, and in the process strengthen the artist community. Locavesting is at its core investment choices that support and sustain the local community.
Emerging market movements indicate that even in a time of bailouts and stimulus packages, capitalism is still alive and growing. Markets are evolving and individuals are having a say in that evolution. Many of these markets are now facing challenging times, however, and their future will say a lot about how our society and government value the marketplace.