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 may be an extreme example of the small group of informed traders who actually influence prices on platforms like Polymarket, while the majority of traders lose money around them. The study, which analyzed over 1.7 million accounts and $13.7 billion in trading volume, found that just 3% of traders are responsible for most price discovery, meaning they are the ones who drive prices towards the correct outcome.
These traders consistently predict outcomes and move prices in the right direction, while the remaining 97% of traders do not. The study's findings challenge the idea that prediction markets work due to the collective knowledge of the crowd, and instead suggest that they work because of the presence of informed traders. The researchers used a novel approach to filter out luck from skill, rerunning each trader's bets 10,000 times to determine whether their profits were due to chance or actual ability. The results showed that among the biggest winners, only 12% consistently beat the benchmark, and many apparent winners did not stay that way.
The study also found that when skilled traders account for a larger share of trading, prices move closer to the correct outcome, especially in the final stretch before resolution. However, the study also raises questions about the risk of insider trading, and highlights the need for platforms to ensure that trading on non-public information is strictly prohibited.
The findings have significant implications for our understanding of how prediction markets work, and suggest that the accuracy of these markets is driven by a small group of informed traders rather than the crowd.