By Jen Saarbach & Kristen Kelly, Co-Founders of The Wall Street Skinny
There’s an old joke on the trading floor: “What’s the difference between a Treasury trader and a swaps trader? Swaps traders can see the future.”
The reality is, all interest rates trading at its core is a continuous referendum on what’s going to happen in the future. What will the impact of future growth, inflation, monetary, and fiscal policy be on a series of fixed cash flows I am supposed to receive days, months, years, or decades from now? The derivatives market in particular has been the primary vehicle for pricing that out.
And I spent the better part of a decade looking at the traditional platforms where trillions of dollars worth of capital were put to work trying to tease out the answers to those questions, like Bloomberg, Reuters, and Tradeweb.
So when I saw that Tradeweb, the electronic platform that’s been a staple of traditional fixed income markets for decades, was partnering with Kalshi, the prediction market hub that has exploded in popularity over the past two years, it felt like something had fundamentally changed about the industry I grew up in. And I’m not quite sure how to feel about it.
The framing around prediction markets like Kalshi has ranged from “this is pure gambling” to “these are precise instruments for pricing future outcomes that are superior to traditional markets.”
So let’s get a little more precise, philosophically speaking.
We’ve debated the distinction between “trading” and “gambling” before on our show in the context of traditional markets. Many people feel that the two are indistinguishable, and that there’s no real difference between playing for a tail in a Treasury auction or trying to arb the Treasury futures basis and throwing your hat in the ring at the Blackjack table. I personally disagree with this, but can certainly see the shared characteristics.
A gambler creates, and takes risk for risk’s sake. A trader quantifies risk that already exists in the system, and makes an educated decision as to whether or not the “price” of that risk is right. Traders who simply treat the markets like slot machines have historically not been rewarded, at least not for very long.
That being said, bond markets are in a very real sense probability machines. Take, for example, a 2 year Treasury note. When you buy a 2-year note at any given yield, you are fundamentally expressing a view on the cumulative path of the Fed Funds rate over that horizon. Strip out term premium and inflation expectations, and what you have left is essentially a market-implied probability distribution of future policy outcomes. But Treasuries aren’t the only vehicle for expressing that view. Fed funds futures, Eurodollar (now SOFR) contracts, and interest rate swaps have long served this function. Buying or selling any one of these instruments can win or lose big when monetary policy changes. As such, trillions of dollars of capital is often teetering on a knife’s edge when Fed Chairman Powell decides to change a comma or a preposition in any given FOMC statement.
Those investors are typically said to be trading. Someone making a binary bet on Kalshi as to whether or not the Fed will cut rates by 25 basis points at their next meeting might be said to be gambling. So, what’s the difference?
Prediction markets let you do something structurally similar to traditional fixed income trading, but with key distinctions. Where a 2-year SOFR swap rate represents a number of different factors beyond just monetary policy, such as balance sheet premia, funding market stress (or lack thereof), rate lock activity, supply and demand dynamics, etc., a Kalshi contract on a 25bps Fed cut isolates a binary outcome. $1 if you win, $0 if you lose.
“Okay,” you might ask, “but what about a Fed Funds futures contract?” Well, the minimum size on a Fed Funds futures contract is $5mm notional. For an institutional investor like a money manager or a hedge fund, that’s pocket change. For the rest of us, that’s an astronomical amount. So the prediction markets have served the function of “democratizing access” (everyone’s favorite buzz-phrase) for those who want to express a view on these same outcomes, putting much less money at risk.
Another distinction is the risk around asymmetry of information creating an “unsafe” market environment. To be fair, Kalshi’s contracts are regulated by the Commodity Futures Trading Commission (“CFTC”). This means that there are position limits, reporting requirements, margin rules, and other guardrails in place to protect market participants.
That’s all well and good. But they aren’t subject to the same SEC regulations that govern most traditional securities exchanges. Many firm compliance policies may not have adequate coverage to account for a market that is transforming in real time. So if you’re an insider at an institution that you know is initiating a massive position in the conventional markets, what’s to stop you from placing a bet to benefit in your personal account? Fed Funds futures contracts may not move on a 1:1 ratio with a Kalshi contract, but one may influence the other. Bad actors could certainly profit in a way that they previously were unable to due to the size limitations of the market.
The broad adoption and massive uptake of prediction markets like Kalshi means that they need to be incorporated into the more heavily regulated world currently occupied by traditional exchanges if they are going to avoid what feels like an inevitable insider trading or market manipulation scandal.
So, what’s actually happening now? Per Bloomberg, Tradeweb will start by showing real-time prices for Kalshi’s contracts and distributing that data to its users. Down the line, they may add trading capabilities. Tradeweb will also take a stake in Kalshi. This deal follows on the heels of ICE’s investment in Polymarket, and is likely just the beginning. To me, it’s evidence that the established exchange and platform operators believe prediction markets are here to stay, and would rather bring them into the fold in an orderly manner rather than waiting to see if their business is threatened.
What does this mean for the markets we grew up in?
In the near term, I do think prediction market data will just become one more input into the way traders price risk. Fed meetings, CPI prints, Non-farm payrolls, Treasury auctions, election outcomes, all these events are heavily traded in the fixed income derivatives markets through event day weighting, and they’re all natural candidates for event contracts. Incorporating data from Kalshi should, if anything, help traders refine their event day weighting models, as long as that data is treated with healthy skepticism.
If Tradeweb does add trading capabilities for prediction contracts, then the universe of binary contracts goes from its current form (bespoke derivative contracts priced by exotic options desks with massive bid/offer spreads) to a more efficient and less costly suite of options that increase any given portfolio manager’s ability to hedge risk.
But back to our philosophy conversation. The transformation of the market won’t be instantaneous. Here are the biggest questions I’m asking as these developments materialize:
- Is more information always better? What if the current hierarchy of information that has driven the bond markets since time immemorial crumbles, and they are reduced to the fate of the meme stock?
- Will there ever be enough liquidity in these products to be meaningful for institutional investors?
- Will the OTC derivatives market ever be supplanted by binary bets? What happens to the rates market we know and love if prediction market liquidity starts to rival that of traditional products, like swaps and options?
- Will unconventional things like election outcome betting actually become part of institutional investment portfolios? What will the world look like if hedge fund managers start placing size bets on behalf of their institutional investors on political outcomes? And will the tail start wagging the dog?
This won’t happen overnight, but it does feel like a bit of a pivotal moment for the rates world. And if history is a guide, those who have stood in the way of market innovation tend to be forgotten. Perhaps the summer intern class of 2028 will be expected to upload their Kalshi portfolio as evidence of their qualifications in lieu of a Hirevue.