Research Reveals That a Small Group of Informed Traders Drives Prediction Market Accuracy

A recent scandal involving a Green Beret who was arrested for betting on a classified US raid may be more than just an isolated incident. According to a new study, it could be an extreme example of the small group of informed traders who actually influence prices on platforms like Polymarket, while the majority of users end up losing money. The study, which analyzed 1.72 million accounts and $13.76 billion in trading volume on Polymarket, found that just 3% of traders are responsible for the majority of price movements, with these individuals consistently predicting outcomes and moving prices in the right direction. In contrast, the remaining 97% of traders tend to provide liquidity and generate volume, but ultimately end up on the losing side of trades against the informed minority. The challenge lies in distinguishing between skill and luck, as many traders may experience big wins by chance alone. To address this, the researchers simulated each trader's bets 10,000 times, using the same markets, moments, and dollar amounts, but with the direction of the bet determined by a coin flip. This allowed them to establish a benchmark for what each trader's profits would look like without any real edge. The findings showed that among the biggest winners, only 12% consistently outperformed the benchmark, and many apparent winners did not sustain their performance over time. The activity of skilled traders was found to improve market accuracy, with prices moving closer to the correct outcome, especially in the final stages before resolution. These traders were also the first to react to new information, such as Federal Reserve announcements or corporate earnings, while other traders showed little consistent reaction. However, the same edge that makes skilled traders valuable to price discovery raises concerns when it involves non-public information. Both Polymarket and Kalshi have stated that trading on non-public information is strictly against their rules. The study highlights the risk of insider trading, citing the example of the US removal of Nicolás Maduro from power in Venezuela, where three newly created Polymarket accounts placed large bets on the contract before the price moved, collectively making over $630,000. While insider trades are rare and concentrated in a handful of events, they can have a significant impact on prices. The findings challenge the idea that prediction markets work due to the collective knowledge of the crowd, instead suggesting that they work because of the informed traders who drive price discovery.