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Fee structure distorts the market

Hi, others have alluded to this, but I haven't seen anyone come out and say it directly.  The current fee structure prevents this market from functioning properly.  Ask any economist, if you have a 10% take on profits and a 5% withdrawal take, you are going to influence behavior.  In this case, it has the effect of preventing most arbitrage, because gross spreads on trades have to be extremely large for it to make economic sense to put money on this site to do an arbitrage.


I get that the site is non-profit, and there are real costs to running it (for the record, I would not be against a profit for the site).  That said, I don't understand though why there isn't a subscription option for users, as it would eliminate the effects the fees are having on the market, which would create more realistic odds (assume that is academic purpose?) as well as a better experience for users.


A few examples specific examples:


a) The current Republic nomination odds are a joke.  They add up to well over 100% (top 7 alone add up to 139% on the "sell-yes" side of market right now, which is the easiest way for me to think about it, all 21 add up to something like 180%).  Let's say I sold 850 shares of each of top 7, that would cost me $4,769.  If none of them wins (not impossible), I make $1,181, or 25% gross.  More likely, one of them wins, and costs me $850, so I really make $331.  That's still 7% gross, and a 10% IRR to the republican convention.  That's a big spread.


In reality though, I'm going to have to pay ~$100 fee on my gross winnings depending on who wins (10% of my gross and I can't deduct the $850 loss I had to take to get here!).  I also have to pay 5% to take the capital back off the site, assuming I didn't want to let it all ride after the arbitrage (that's another $250-ish based on my 4,768 + ~$230 gross gains).  That is all my winnings.  I have a 7% guaranteed gross trade, and I can't make any money on a net-basis.  This is why the odds don't make any sense on the site, because the fees prevent arbitrage. 


b) Just to point out that this isn't the only place where such a discrepancy exists, Hillary + Bernie odds for winning the general election right now are 69% on the offer side, despite democratic odds of winning presidency at only 61%.  This is a huge spread for a normal market, but when you consider you'll be taxed on profitable trades, without an offset for losses, it's not very interesting.  


I could go on - you will notice nearly every question has odds that currently add up to well over 100%.  No one can take advantage of this because no one wants to add too much capital to the site since they're going to get hit with a 5% cut across the board to remove it later.  


Again, I want to be clear I am all for the site making money, but how it is structured today is influencing the odds and distorting the market in obvious and illogical ways.  For sake of argument, let's say site was willing to allow users to opt in to an alternate $350/yr subscription rate as the only fee (which seems very high for most users, but is in line with the fees generated from the trade above).  Who wants to bet that the spreads above would collapse within days?  I think it would meaningfully improve efficiency/accuracy of the market odds, and would still allow plenty of room for a very nice business margin/model for the operators and I'm guessing most users of the site would happily opt in at a more reasonable price point (maybe ~$100/yr?) although I'd love to hear others' thoughts or opposing viewpoints.




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I couldn't disagree more with freelancepope. 


The 5% withdrawal fee is needed to offset the credit card processing fees the PredictIt incurs when we make deposits. It provides an appropriate incentive for traders to move money in and out of the site more than necessary and does not distort prices or substantially deter new traders. If withdrawal fees were capped, that could lead to abuses where people use PredictIt deposits just for the credit card rewards, making PredictIt (donors, other traders) bear the costs of processing the CC transaction. I really think the only problem with the current fee structure is net vs. gross issue (though I would also prefer fees to be based on average cost rather than FIFO) and that fixing that in a revenue-neutral way would be a huge improvement, second in importance only to rapid implementation of margin-linking.


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I agree entirely with gk123's point.  It seems to me that Predict It has an academic / research mission of developing a prediction market to tap the wisdom of crowds, combined with the discipline of putting real money at risk, to the ultimate goal of getting the best available estimates of various probabilities.  That goal has been thoroughly undermined to date by (a) the lack of linked-contract margin which makes arbitrage require a very high ratio of capital to profit and (b) the illogical fee structure which makes arbitrage an unprofitable activity except at absurdly high spreads.  Either a subscription model like gk123 lays out (though I would hope $1-2 per month would be sufficient) or a per-contract-traded fee ($0.001?) would work, or the greater of the two to effectively penalize inactive accounts and allow the site to have sufficient revenue when activity inevitably falls off a bit post election.  This would allow PredictIt to be much more successful in achieving its own goals.


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I actually think PredictIt's basic fee structure could be made to work if it were based on NET profits, in a market group rather than gross profits on and individual contract. Monthly fixed fees tend to keep away smaller traders (who might eventually become bigger traders), and trading fees create there own distortions, particularly for extreme prices (below 5, above 95). The latter can be made to work pretty well by lowering the trading fees at the extreme. In any case, the primary source of distortion for trading fees is based on use of gross fees on individuals markets. 


Though I think gk123 is overstating the impact of the fee structure in the GOP presidential nomination market (I think the main distorter there is the lack of margin-linking, requiring large capital outlay for shorting multiple contracts). Nonetheless, the fee structure does create significant distortions. I think these are easier to see in the Party Prez market. Here, the bids on the GOP and DEM yes contracts regularly sum to around 101 or 102 (with the asks summing as high as 108), in addition to the Other contract which has typically had a 4-7 spread.  Margin-linking is still playing a roll here, but even if the market was linked, the return on across the board are limiting by the role of fees on gross profits. For simplicity of the math, assuming you can sell D at 60, R at 40, and O at 5. Without fees, you expect a 5 cent profit for shorting across the board. With fees, you pay 4.5 cents if the Dems win, 6.5 cents of the Rs win, and 10 cents if Other wins, for a net profit of 0.5 cents, -1.5 cents, and -5 cents, respectively. The market has to overbid by about 10%, before it is really worth it to short across the board. If fees were based on net profits in a market, however, there would be no disincentive to sell across the board until the bid total is brought down to 100.  Note that this is true even if the fee percentage is raised substantially to offset the revenue lost due canceling out phantom losses (basically "losses" made in fully hedged positions). I would rather see a fee of 25-30% on net profits than the current 10% on gross profits. 


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The 10% on profits is fine, there just needs to be a cap on the withdraw fee.


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I don't think this is a good idea. monthly fees would turn away a lot of new potential users. also linked margin will fix most of the problem with overpricing. Just look at the Obama weekly market, bids rarely sum to 100% and if you ever get to 108% people start hitting out bids to arb. Running the site on a monthly fee would turn away almost all of the new or more casual traders, which would kill the market. You can't have a functional ecosystem with only sharks in the water.

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gabewell:

I think the basic reason that the 5% withdrawal fee is significantly worse (for market efficiency) than the 10% fee on profit because it sets a lower bound on the rate of return needed to make arbitrage profitable. 

As an example, suppose that the price of Hillary's No shares in DNOM plus the price of Bernie's No shares in DNOM is 0.9. This compound purchase gives a guaranteed return of 1, so the pre-fee rate of return of this trade is 1/0.9 = 1.11. If you spend $90 and buy 100 No shares for each candidate, then your pre-fee revenue would be $100, so your profit is $100-$90 = $10. The 10% profit fee brings this profit down to $9, which means you are still earning a rate of return of 99/90 = 1.1. 

By contrast, if you wanted to withdraw this $99 from your account, you would only get $94.05, so this fee brings the rate of return down to 1.045. You see how significant this difference is?


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Just to reiterate what has been posted here, taking 10% of gross profits in a linked market instead of 10% in net profits in a linked market, (1) makes no sense and (2) distorts the pricing in a market.  I'm not aware of any other prediction market that does this when the markets are linked.  It undermines the customer and the market.


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Appreciate hearing others' thoughts.  A few responses from my perspective:


hvpark:  I don't think it's either/or.  It is fine to continue to allow current fee structure to stand as an option - I agree for many users, paying a subscription wouldn't make sense.  That said, allowing heavier users the option of opting in to a subscription would significantly improve the accuracy of the market, as I pointed out in the original post.  


Freelancepope:  capping the total withdrawal fee has a similar impact to a subscription.  I'd be fine with it as an alternative, if that is somehow easier than setting up a subscription. 


gabeweil:  Credit card processing fees vary, and I agree that it is clear this fee is a partial offset.  That said, if the whole 5% were going to credit card processing, we have found our problem right there.  It would imply nearly all the fees the site takes in are going to 3rd parties.  They could save everyone a boatload by offering to waive/reduce the fee if you link a bank acct or use paypal instead.  In reality, I think a meaningful % of that 5% must be going to support site infrastructure / running the project, and thus it could be assessed in a different manner so that it doesn't distort the market.  


I do agree with your net fee construct and margin-linking being two key issues that would improve the market.  That said, I would point out that a 25% net profit fee combined with a 5% withdrawal fee will still result in gross spreads in most markets being near double-digits before there is an opportunity to create any profits for users.  If no alternative fee model is introduced, the overall market odds will continue to suffer.  


Not to beat a dead horse, but does anyone here really think there is a 94% chance Rubio, Cruz, or Trump is the republican nominee?  (46, 24, 24 right now).  What is the message we should draw from those odds?  I think the only rational thing to believe is that they are surely far too high, and probably mostly useless when trying to draw meaningful conclusions from the data.  Ben Carson is currently trading at an 8% chance of winning the nomination and also an 8% chance of winning the presidency.  Do you think that tells us something about his chances of winning and/or launching a 3rd party bid, or do you think it tells us that fees prevent anyone from taking the "No" side of the bet profitably below about ~8%?  Assuming the research purpose of this site is to aim for a market that produces accurate (or at least useful) results, I don't think this is a small issue.  


Here is the New York Times weighing in on the site's odds: http://www.nytimes.com/2015/10/24/upshot/betting-markets-call-marco-rubio-front-runner-in-gop.html?_r=0


"Traders at Betfair, which is the world’s largest betting exchange, but which doesn’t take bets from Americans, rate Mr. Bush a 20 percent chance to win the nomination, while Mr. Rubio is given a 29 percent chance. Over at PredictIt, which is a small-scale experimental prediction market popular among American hobbyists, traders have moved more decisively, giving Mr. Bush a 24 percent chance, compared with Mr. Rubio’s 40 percent. (A peculiar inefficiency in that market tends to overrate the chances of all of the candidates, so both of these numbers are surely too high.)"


Indeed.


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I'm new to all this, but would a (credit-card processing) fee on DEPOSITING funds take care of the market distortions? I suppose after that, the 10% on profits is Ok with me. Then there could be a nominal flat fee for issuing checks and postage. It seems weird to me that there's a percentage to withdrawal that's presumably applied to my deposit. Applying a deposit fee should yield the same profit for PredictIt. It would just charge everyone on the way in instead of only the winners on the way out.


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I think that all profits should be assessed at time of withdrawal.


Others have pointed out the distorting effects of charging a fee on gross, rather than net, profits. For a single market. Changing from net to gross would have the desirable effect of enabling arbitrage within a linked market. However, there still is no possibility to arbitrage or hedge bets between markets. 


For example, if I think that the implied odds of Bernie winning the presidency given that he wins the nomination are too high, I should be able to take out a 'yes' position on Bernie-nomination and a 'no' position on Bernie-Pres, in effect betting that he will be nominated and will lose the presidency. However, owing to the fee structure, this becomes a very unfavorable proposition.


It should work like this: at time of withdrawal, current funds are evaluated. If you are above your initial deposit(s), then you pay a high rate (25%?) to withdraw any profits, and then the lower 5% rate to withdraw any further amount. This way, your losses get amortized and if you make many +EV bets, even slightly (<<10%), you can make money in the long run.


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The withdrawal fee should not exceed the cc processesing fee for deposits plus a small check fee at most. I've made over $14k profit above the 1.35k I put on which means I'm already paying a withdrawal fee equivalent to half of my starting bankroll....wow.

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Isaac,

Indeed, the fee structure makes it very difficult to turn an expected profit on this site, especially if you are planning to make only a single trade. It's disappointing that PI has not addressed this issue, and I hope that they do so very soon.


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Will the responsible persons at PredictIt tell us at some time what they think about the suggestions and what they intend to do in the future?  Reading no feedback at all makes me wonder if PredictIt will change anything without market pressure when traders migrate to another better site.

. . . I find the 5% withdrawal fee OK, but the 10% profit fee too high, because, as the original posting stated, it prevents arbitrage, and it prevents connecting bets well to each other.  5% on winnings would be a better value.  This is no casino with bettors relying on pure luck, and the lucky ones compensating the staff.  On the other hand, a subscription fees puts up a barrier and punishes the infrequent traders who might add valuable knowledge to outcomes of some bets.

. . . I saw the difficulty to make informed bets by once betting a lot on YES for a bet A, while I expected it to result in YES only if a bet B had a YES outcome, too, which seemed unlikely though.  I betted a lot on NO for bet B, to hedge my YES on bet A, which turned out to be necessary, because bet B, unexpectedly, turned to NO and so did bet A.  Still, I had to pay the full 10% fee on my winnings for bet B and couldn't get my losses on bet A subtracted first, despite this being one combined bet.

. . . One other thing for PredictIt to keep in mind is the return of inflation.  Right now, I don't mind keeping thousands of dollars at PredictIt, because I wouldn't earn interest at a bank.  If inflation returns and interest rates rise again, this changes, and my willingness to keep money at PredictIt without due compensation will fall.


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PredictIt Staff,


Your markets will never be efficient.


If you add up all the "SELL NO" numbers on the Obama Gallup approval polls ending April 15 right now, they add up to 106% (maxing out buying $850).  Of course, the buy yeses are much higher.


If I buy all the nos, no matter which contract wins I will lose $$$ because I'm paying the fees on gains for the contract that wins (go ahead and calculate it or reach out to me for the scenario analysis).


So, my answer is no thanks - and the market stays inefficient.


As mentioned a few times in this thread, if all the contracts close and I pay the fees on my 7% market-ending gains rather than contract-by-contract, that actually makes some sense and will encourage smart traders like many of us who want to arbitrage.  And congrats!  You will have efficient markets.


As a top economics graduate and trader, this fee structure is pretty disappointing.  If you change your fee structure, you will make us happy and your markets will become efficient.  When will this change finally be done?  I haven't read all the  replies, but it doesn't look like any are from support.


Best,

MarketMaker25


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Part of the fundamental issue here is getting enough volume of trading so that fees can be low also there are some revenue sources beyond trading fees that need to be considered. If Volume were really high, I think the whole site could be run on a small percentage of the "float" or interest on the deposits placed at predictit.org In fact if volume were high enough, those deposits might be interest bearing which would make long term bets more feasible. In the meantime, I think we need to consider any options that will increase trading volume and a clear policy to lower fees as volume increases. One option might be to give folks a fee credit for referring other customers to the site.

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