You can’t always get what you quant: Sports has supplied prediction markets with the retail volume, liquidity and public visibility required to turn the sector into a significant business. But it is the institutional interest that might yet be the major play.

• Since last Friday, the Ninth Circuit has unanimously rejected Kalshi’s attempt to prevent Nevada from enforcing its gaming laws against it and New Jersey has requested that the Supreme Court step in to decide the matter.

But if you try sometimes, you’ll find: Yet the institutional prediction market proposition does not depend entirely on whether NFL contracts, player props and combos survive that fight. Jordan Bender, analyst at Citizens, sees a potential demarcation between sports-led operators and businesses targeting the wider trading opportunity.

• In his formulation, “sports-betting companies take the sports side and everyone else takes everything else,” although regulation or a Supreme Court ruling could move that boundary.

You get what you need: For Susquehanna Predictions, the larger opportunity lies in using event contracts to transfer risks that institutions currently hedge indirectly. Joe Grubb, head of business development, said the company is seeing “material institutional demand” from hedge funds, asset managers, financial services businesses and corporations.

• Areas of interest include economic data, company performance, regulatory outcomes and AI input costs such as compute prices.
• The advantage is precision. An investor worried about a legislative outcome might presently construct a basket of shares expected to rise or fall if the law passes.
• That introduces basis risk because the basket will also move for reasons unrelated to the legislation.
• “Prediction markets allow for a direct hedge, reducing basis risk and making the risk transfer much more efficient,” Grubb said.

A witch you made to measure: Susquehanna is prepared to quote larger sizes than those displayed on exchange order books and to help create bespoke contracts for institutions with a bona fide hedging requirement. Crucially, it does not always need to find an immediate matching customer.

• “We operate differently from most traditional market makers in that we’re willing to warehouse risk,” Grubb said. “We don’t necessarily need to offload or hedge that risk.”
• Susquehanna recently provided a tailored legislative hedge for a goat farmer whose business could be affected by a change in the law.
• Grubb said the potential was “very substantial,” adding that the company was willing to warehouse unusual risks to help establish the market.

The shallow end: That does not remove the liquidity problem, however. Ed Engel, analyst at Compass Point, said retail participation normally precedes market makers and institutions. Sports has generated that progression, but most non-sports contracts remain too shallow for meaningful institutional positions.

• “The problem I hear about prediction markets right now is that, outside sports, there isn’t nearly enough liquidity for institutions,” he said.
• The $10m trade between Galaxy Digital and crypto hedge fund Arca concerning passage of the CLARITY Act demonstrated one possible solution.
• Galaxy acted as counterparty and hedged its exposure through other instruments while looking to distribute risk through the event-contract market.

Quants and needs: Engel compared this with the work already performed by derivatives desks and structured product teams. An intermediary gives the client the precise exposure it wants, charges a spread and then uses correlated markets to manage the resulting position.

• “The people at Susquehanna aren’t sitting there forming personal opinions on whether something will happen,” Engel said. “It’s all quantitative. That’s what this is likely to become.”
• Those ingredients are beginning to appear. Cantor Fitzgerald now introduces institutional clients to Kalshi block trades, with Susquehanna supplying prices and liquidity.
• Susquehanna and Robinhood have also launched their own exchange, Rothera, built specifically for institutions.

Ready when you are: But infrastructure does not equal adoption. Major banks have established systems, cautious compliance departments and little reason to enter an immature product category before clients demand it.

• “We aren’t seeing JPMorgan do it,” Engel said. “I think it will come, but these things take a lot of time.”

Repeat business: Capital efficiency is another obstacle. Current block trades are fully collateralized, making longer duration positions expensive to maintain. Grubb said margin would be an important component of wider adoption as institutions weigh the advantage of reducing basis risk against the cost of tying up capital.

• The proof points will therefore be repeat institutional block trades, deeper markets and more firms incorporating prediction market probabilities into investment decisions.
• Grubb expects participation announcements to create a cascading effect as competitors decide they cannot afford to ignore the category.
• But he stressed that institutional trading remains in its “early innings” and Engel is also cautious.
• He suggested banks will become involved only when their clients start asking for the product.

Like what you are reading? CLICK here to read the FULL article!