(TL;DR for the lazy: widespread government insider trading on prediction markets could lead to consistently rash, inconsistent, sudden, inexplicable, or outwardly awful decision making in the trump admin)

Using prediction markets as a means to improve forecasting has been a discussion in economics and rationalist circles for decades now. In 2000, economist, polymath and weirdo extraordinaire Robin Hanson proposed a type of government he called a Futarchy, in which policies were decided by prediction markets, while voting was relegated to choosing core values.

While the idea was well received, few seriously believed the government could actually be run by prediction markets in the near future. The political willpower just wasn’t there. So none really expected to find themselves in the situation that the USA at present seems to have found itself, in which policy might indeed be decided by prediction markets, just not quite in the way that Hanson wanted.

The last two years have seen two major political changes in the USA in regards to prediction markets. In October 2024, a court ruling effectively legalised prediction markets. One month later an election took place, and the US government was suddenly being staffed by the sort of person who very plausibly would get involved in insider trading on prediction markets. Thus in the span of a month, something that was previously unthinkable - widespread prediction market fraud in the US federal government - became very possible.

The purpose of this post is not to prove that prediction market insider trading is rife within the Trump administration. If it is the case, then I suspect it will take another admin to do the sufficient investigatory work to prove it. We have some reasonable circumstantial evidence, but not much more.

Instead, I want to explore what happens if it is true. I’d like to sketch out what political economy looks like under the following assumptions:

1. Prediction markets for policy choices exist.

2. There is a community of policymakers with heterogeneous levels of control over different types of policy choices

3. Policymakers follow their rational interest in profiting from prediction markets.

4. The volume of trading on prediction markets by policymakers is non-negligible to the market at large. That is, the betting decisions made by policymakers shift market prices considerably.

Assumptions 1 and 3 are self explanatory (Just keep in mind that I’m using ‘policymaker’ as shorthand for anyone in the government who has the ability to make the choices that are bet on on prediction markets), but 2 needs a bit more explanation. See comments for a quick note on assumption 4.

It is not controversial that Donald Trump does not keep up to date on the minutiae of the decisions his administration makes. All executives must delegate decisionmaking to various degrees, but the extent of Donald's disinterest in the actual content of his policies is, by most accounts, unprecedented, and there are countless stories about the politics around making sure that one is the last person to talk to Donald before the decision gets made (as he will famously agree with the most recent person to advise him). In any case, I think its reasonable to model the decision making of the US government as not having a single ‘head’ but instead being a heterogeneous network of individual policymakers each with their own policy domains over which they have more influence.

Now, supposing each of these policymakers has no moral objection to insider trading on prediction markets, nor will they suffer any negative consequences (e.g criminal charges for doing so), what would we expect to happen?

Firstly, the profitability of prediction market insider trading is inversely correlated with bettors' expectations that the market is not being manipulated as such. Nobody will bet on a market where they know that the outcome will be determined by someone who is betting on it. Thus, the policymakers have a strong incentive to signal the integrity of the market. All involved want to be quiet about it.

Secondly, if assumption 4 holds, and actually the size of the bets being made by insider traders does have a tangible impact on market prices, then policymakers now have conflicting interests. They will not form a ‘cabal’ - rather, the profitability of one’s insider trading depends on your ability to keep your privileged information privileged. Thus we would expect to see insider information being passed around in tight sub-networks, rather than shared with the whole. Information becomes a scarce resource, traded around as favours, and one’s influence and wealth depends on how much of it you can find.

Thirdly, and importantly: The profitability of insider trading correlates negatively with the dispersion of reliable information about upcoming government choices. Suppose there is a bet over a decision that will be made in a week’s time, and you have prior access to what that decision will be. To pass that information along to anyone - either in the government our outside of it - will directly result in not only you making less money, but in less profit for the person who actually gave you that information. The information is valuable because of its scarcity. We would thus expect to see a high degree of secrecy from the administration about upcoming choices, and any information that does come out would serve to fuel speculation, rather than outward confirmation, at least up until the moment the bets are called in. Going further than this, the policymakers have good reasons to signal false information about upcoming policy choices, both to each other and to the public. The rational policymaker would like to publicly say “We will not enact policy X”, then take out a bet on enacting policy X, then enact it. We must expect widespread lying, especially in informational conditions in which lying is not disincentivised.

Fourthly: Note that the profitability of a bet on an outcome is inversely correlated to the odds of that bet on the prediction market (obviously) - insider trading policymakers are therefore incentivised to profit by making decisions that outsiders believe are highly improbable. We would therefore expect to see the government make decisions that seem to go against all common sense.

Fifthly(?): For the betting market to be profitable at all, bettors need to believe that there is some sort of pattern that they can follow. While, as per the previous paragraph, the policymakers have incentive to be maximally contrarian to the market, they would like outsiders to believe that they are following some sort of pattern, that there is some sort of underlying program. The policymakers will thus constantly signal that they are following an intelligible principle, but will either not give specific information about what that principle entails, or change it retroactively.

Lastly, I expect that such a scheme would be whistleblower-proof, since we would expect to see such information being passed around in dense and secretive subnetworks. You would not expect there to be a single group chat where all the trump staffers would share all the prediction market scams they are currently operating - doing so would go directly against their own incentives, and make their valuable information cheap. Thus, each individual participant would not know about any insider trading except that which is happening in their own local subsection of the network, and to blow the whistle would be to report one’s self or one’s own allies. Individual leaks may occur, but not that of the whole system.

I have neither the skills or time to model this mathematically to a degree that would be publishable in an economics journal (although I have my own intuitions about how I would do it if I could). But I strongly suspect that all of this would have the consequence of making government policy choices random and irrational. That is, policy choices and the information surrounding them would, in equilibrium, be chosen as to minimise the policy’s predictability. Bettors would notice that the government frequently chooses the less probable actions, thus evening out the betting odds and making improbable outcomes more likely across the board, reflecting this increased unpredictability. When new information comes out to make one outcome more likely, the incentive to do the opposite thing becomes greater. Thus the decision making of the government itself approaches randomness from the perspective of an outsider.

I cannot prove that any of this is actually happening - this is just what I think would happen if the government was full of rational actors willing to engage in insider trading. I will point out, however, that this model would predict the following:

• Extremely erratic decisionmaking from the government, often choosing the least sensible thing to do or say in a given moment. A tendency towards sudden and rash decisions with little prior warning.

• A high degree of secrecy about upcoming policy choices. More government decisions being announced more by unverified rumours than press conferences.

• Repeated insistence that he government’s choices do follow some sort of plan or principle, but a lack of willingness to tell us what those principles are, and frequent reversals of such principles once stated.

• High ranking officials working against each other and reversing each other’s decisions seemingly at a whim. Even insiders not having a clear idea of what's going on.

I leave it to the reader to decide for herself whether or not this sounds familiar.