Study Reveals That Only a Small Group of Informed Traders Drive Prediction Market Accuracy

A recent scandal involving a Green Beret accused of betting on a classified U.S. raid may be more than an isolated incident, as a new study suggests that a small group of informed traders, like the soldier, are the ones actually influencing prices on platforms like Polymarket, while the majority of users incur losses. This study, conducted by researchers from the London Business School and Yale, analyzed 1.72 million accounts and $13.76 billion in trading volume on Polymarket, revealing that a mere 3% of traders are responsible for the majority of price discovery. These traders consistently demonstrate an ability to predict outcomes and move prices in the correct direction, in contrast to the remaining 97%, who primarily provide liquidity and generate volume, but ultimately end up on the losing side of trades. To distinguish between skill and luck, 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. The results showed that only 12% of the biggest winners by raw profit consistently outperformed the benchmark, indicating that their success was due to skill rather than luck. Furthermore, the study found that when skilled traders account for a larger share of trading, prices move closer to the correct outcome, especially in the final stages before resolution. However, the same edge that makes skilled traders valuable to price discovery also raises concerns when that information is not public or is not supposed to be. The paper highlights the risk of insider trading, citing the example of the U.S. removal of Nicolás Maduro from power in Venezuela, where three newly created Polymarket accounts placed unusually 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, the study's findings challenge the idea that prediction markets work due to the collective knowledge of their participants, instead suggesting that they work because of the informed minority.