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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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mahany25:


First off, your calculation of fees on 10% profit is wrong. The current system bases fees on GROSS profits, which is my main problem with it. Your calculation is for what fees would be assessed on NET profits. Read my posts above. 


So, if you buy Clinton No at 10 and Sanders No at 80 (the market is no longer this overbid, but I'm using your 90 combined price), then you feel will be depend on who wins. If neither wins, that's great, you win 90 on clinton no shares and 20 on sanders shares, and get charged fees of 9 and cents per share. Yippee.


If Clinton wins, you lose your 10 cent investment in each of those, but win 20 on each Sanders, for a 20 cent Gross profit. You are charged 2 cents per share, so your net profits after fees are 8 cents per share.


If Sanders win, you make 90 cents cents per share on your Clinton No position and are charged 9 cents per share in fees. On Sanders, you lose 80 cents per share, Your net profit per share is 90-9-80=1 cent per share. If you had to pay 85 for those Sanders No shares, you would have lost 4 cents per share, even though you bought them for a combined 95 cents.


This is why I think they should move to fees on NET profits, even if it requires a significantly higher percentage.


As for your calculation on the 5% fee, that assumes you only use funds for one bet before withdrawing. Why assume that? It seems like arbitrage-inclined traders are precisely those that should be expected to roll funds over into new markets once one markets resolves itself or prices get bid to more reasonable levels. I know I certainly don't plan to pull all my money out after nominations are resolved. You only pay the 5% once, so the impact of the fee on any particular market hard to tease out. If the fee will probably make me more reluctant to to pull money out and after the general election and instead look for markets to trade until the next election cycle, as opposed to pulling my money out and then having to pay the 5% again. As I've said before, if this fee can be reduced (including via alternative deposit options), that's great, but the fee on GROSS profits is a much bigger problem.


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Gk123:

I sent a brief feedback message to them before coming to the forums. I'm very glad to see you already made all the points much more coherently than I could have.

My tl;dr point: no withdrawal fees would attract more (presumably smarter) money to the website. The increase in gross trading would yield a higher gross amount being subject to fees on profits. Smaller percentage of a higher number, yaddah yaddah.

The assumption is an increase in users and activity would not cause an increase in costs, and more narrow (I'd say more reasonable) fees would be beneficial for both the accuracy and profitability of the markets.


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GK123:


First off, let''s clarify what I think we agree. 


1. Moving in a revenue-neutral way (25% is just a number I through out, I suspect it would actually be lower) to net fees would be an improvement, and less distortionary than the current structure. In your SCOTUS example, a 10% fee on gross profits would basically wipe out all gains if the market were at 109% and could even result in losses for an across-the-board shorter if the a long-shot (below 10) result occurs.  


2. Some fee on withdrawals is necessary to cover CC processing fees, at least until they offer an alternative deposit option (with fee waiver / reduction).


3. While my proposed fee structure avoids turning profits into losses, it does reduce expected rates of return such that some trades or strategies will offer less attractive risk/return options than alternative investments, even when the market prices are clearly wrong (e.g., the market is overbid).


Let me know if you disagree with any of that.


I don't really have a problem with PredictIt offering a monthly subscription as option, but I do see some potential issues.


1. It would have to be optional to avoid deterring new traders from joining. At a minimum this would increase complexity and administrative burdens for PredictIt.


2. To be revenue neutral, the fee would have to be set fairly. This is because the most active and profitable traders are the people most likely to take advantage of the option. The fee would have to replace the significant revenue those traders generate. 


3. The higher the fee is set, the fewer traders will join, self-selecting for those with the highest monthly profits. This could require repeatedly raising the fee to make up for revenue shortfalls, possibly resulting in a death spiral. Basically this is an adverse selection problem. I think part of the appeal of a subscription model is that big traders think it will save them money. But if it's going to be revenue-neutral, this really can't be true on average unless there are a lot of small-time suckers willing to pay the fee every month even though they would be much better off just paying the fees on profits.


4. Even if adverse selection doesn't render the monthly option non-viable (maybe they scale it with account balance or trading volume somehow), it is still a cost that would be factored in when comparing alternative investments. If the fee is scaled up somehow to avoid adverse selection, you're going to get back into the problem you raise that the fees lower expected rates of return. There's no really way to get around this problem.


So, while I concede that some distortion would remain under a net profits fee structure, I think it would represent a very substantial improvement over the current structure, without raising the multitude of complications associated with a subscription model. Most of all, I don't want the unwieldy nature and potential pitfall of a subscription model to scare PredictIt off from a more modest change in fee structure that would solve most of the problem.


Finally, I just don't think the 5% withdrawal fee is a big problem. It's not clear to me why it's any more distortionary than any other way of raising revenue. I think both the withdrawal fee on the fee on net profits seem so bad to you because you are comparing them to some ideal fee structure that avoids all distortion. But you get that by assuming away all the problems with the subscription model. If it's going to raise the same amount of revenue (probably needs to do a little more to cover additional administrative burden), it's going to have reduce average rates of return. The big difference (if you could get everyone to sign up for it), is the it would burden less smaller and less successful traders proportionally more, but these are precisely the people who would not agree to pay the subscription. So you either let them keep the current fee structure or lose them entirely.




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With some plausible assumptions, the incidence of fee is not significantly affected by whether it is a deposit fee or a withdrawal free.


Basically, if you assume constant returns to scale (positive or negative), then you shouldn't care when the fee is assessed. It's the same illusion people suffer from in choosing between a Roth IRA and a conventional IRA. If you have positive returns, you pay a larger $ amount in taxes if you pay on the back end, but all that matters in terms of the end result is the rate you pay.


For example, if you deposit $1000 and double your money, it doesn't matter whether you pay 5% ($50) up front, or 5% ($100) on the back end. Either way you end up with $1900. The same goes for someone who loses half their investment. Using the same $1000 initial deposit, they would end up with $475 regardless of they pay $50 up-front or $25 upon withdrawal.


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Yeah, I understand about having the $850 limit, I just wish it was an $850 limit on the linked market. As it is, I have negative risk in a market and I still can't invest more.


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I have tracked PredictIt markets for a while but haven't ever bet. I saw one contract that seemed very enticing so I signed up and was considering placing a full $850 bet on it. However, I found that the returns didn't seem as enticing as I had thought once I modeled them out. Can someone tell me if the below math is correct?

If I were to buy 1,000 "No" contracts for $0.85 each (So $850 in total), and the contracts go to $1.00, that is a $150 gross profit. Then there is a 10% fee on that which comes out to $15. At the end of the contract, the total amount that would go into my PredictIt account would be $135 plus my initial capital of $850, which means I'd have $985. Then there is a 5% withdrawal fee on the $985 balance, which comes out to $49.25.

So then the total amount that goes back into my bank account is $935.75. This is a gain of $85.75 on my initial $850 investment. I then pay a 35% tax rate on that gain, of $30.01. So my total net gain is only $55.74 (in comparison to my $150 gross profit). The after-tax proceeds are $905.74.

Assume that a contract goes for 1 year. That means I get a 6.6% annual return on the investment (55.75/850=6.6%). The gross would have been (150/850)=17.6%. If we didn't have the withdrawal fee but still had the 10% fee on gains and taxes, it would be 10.3%.

Is this math correct or am I missing something? If so, then I'm calculating that you will lose money by betting on any contract that pays out $0.05 or less (just run that number through the math above). Why would anyone bet on any market that is lower than $0.05? (Someone help me out if I'm missing something)

This is a significant deterrent for me and means that I can't really deposit money and bet on a market unless the fee structure is changed or unless there is an opportunity were the risk/reward is very out of whack. It doesn't really seem worth it otherwise. This means the site is missing out on fees it could be generating from me, due to my opting out.

I don't understand why PredictIt doesn't just let you use your checking account to deposit money rather than using a credit card and then not charge the 5% fee for those users. In the specific opportunity I'm looking at (not the example above), the IRR is 11.7% with the withdrawal fee and 20.8% without the withdrawal fee.

If the 5% fee is truly to offset credit card fees, then it should be free for the site to not charge a fee if I were to deposit from my checking account. In addition, they would actually be gaining revenue by doing this because I would be participating in the market and generating fees, whereas now I am not due to the way the system is currently structured.


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It's true that it's not about winners subsidizing losers. However, disincentivizing people from leaving and not disincentivizing people from joining is going to make it so there's more people on the site. I might not have joined if the fee was for deposit.

I only wish I understood this site as well as you. So this thread was talking about the odds for Trump getting the nob being to high at around 24%.. so how did you make or loose money betting he would or wouldn't?

I think clahey is probably right, but moving the fee to deposits is only a (greater) disincentive to join because of people falling for a cognitive illusion. If there's a few on withdrawals, you're effectively committing to pay it when you deposit. The only ways to avoid paying the fee and losing all your money or leaving your money on the site forever, neither of which constitutes meaningful fee avoidance.

One related issue I want to raise is that the current architecture for putting in orders discourages market-making. If you have a net "yes" or "no" position on a contract, you have to fully close out that position before you can put in orders to take a net position in the other direction. For example, if I have hold 30 yes shares on Marco Rubio to win the GOP nomination, I can't put in an order to sell more than 30 yeses. I have to first sell the 30 to close of my old position, then put in a new order to "buy no". This is fine when you have a big net position one way or the other and just adjust the size of your position in response to price fluctations, and it's fine generally in tight markets where all you want to do is make a bet on one side. But when there's a large bid-ask spread and you want to act as a market maker by putting up both buy and sell orders inside that spread (providing liquidity to other traders in the process and making a small easy profit at the risk of the market moving sharply and leaving you exposed), you are hampered from doing that. Similarly, if you want to put in big orders deep in the order book in case there is a big temporary price swing, as happens from time to time, the current structure often prevents that. This seems like is should be a pretty easy fix, and costless once implemented.  This is quite on point with the fee conversation, but I think it is causing similar issues in terms of impairing the efficiency of the market.

gk123:


How would fees on net profits distort the market? Give me an example of a trade you would make absent a fee based on profits, that you would be deterred from making by a fee on net profits. I totally agree with your points about how distorted and overbid the market is, but with a fee on net profits and margin linking, you would have every incentive to short and push down those prices to a bid total of 100, since you would lock in profits instantly (you can have negative margin positions with margin-linking, as I currently do in the SCOTUS retirement market) and there would be no risk that phantom profits would result in you incurring fees in excess of your real, net profits.


You're probably right that 5% is a little more than needed to cover CC processing fees, but not much more. I think they typically about. 2.5%. There's also probably some internal resource costs in processing the deposits and withdrawals. So, they might be able to cut the withdrawal fee a little bit, but I don't think this should be the focus of concern. If they could processing through bank accounts with a lower fee, I agree that makes sense.




@isaacrose,

As @loconnor said, you're right.  I would also just add that I don't necessarily view it as their main goal to help people make money, BUT:

1) As you point out, several situations still exist where the odds are illogical (ie. wrong) until you understand the fee structure.  If they are using the site for some academic/research purpose this should matter.  I believe the site predictwise has to adjust odds from this side before they can use them because of these issues (and as I posted earlier, the NYTimes has noted in print that the odds here make no sense).  If we're all going to waste our time betting on stuff on this site, it would be much better for everyone if we were creating an outcome (set of odds) that was actually realistic.  

2) I think the structure of the fees is a bigger deal than the size (since it is the way in which fees are levied that influences behavior), but as we've been discussing and you note, the credit card vs. bank account thing is a good example of an apparently unnecessary (and possibly large) expense in the current model.  

Gabeweil:


First, let me say that margin-linking and 5% fee on withdrawals are bigger factors causing inefficiency vs. the net profits fee (assuming it was changed to be truly net across contracts vs. how it works now).


That said, all fees (or taxes) on activity serve to reduce activity.  This is one of the most fundamental building blocks of economics.  I provided a real market example of how the current fee structure does this, including the 10% net profits fee.  Let's assume you fixed everything else, there was no withdrawal fee, and the only fee in the market was the 25% fee on net profits you proposed.


Now, how much $ do you need to make in order to entice you to make a trade on this market?  Let's say there are mediocre alternative investment options and you're willing to accept an 8%/yr return and so is everyone else in the market.  To give you a specific trade, let's use current SCOTUS market, where I believe the 9 contracts currently add up to 109% on the offer side (i.e. you can buy no on them all and lock in at 9% spread).  Imagine you could guarantee someone leaves the court within a year.  Would you trade?  You would in a world where you are paying a fixed subscription to use and support the site, and you do not in a world where you have to pay a 25% tax on your profits (which would reduce your net return below your hurdle rate).  Thus, in a subscription world, we should expect spreads to settle at ~8% annualized, and in a net profits fee world, you need >10% spreads to make a trade that works.


The point here is not that we need to eliminate all fees.  To be honest, if it were only the 10% net profits fee, I would never have started this thread.  The point is, philosophically, levying fees based on user activity on the site distorts the market, and it creates odds that do not reflect reality, but rather reflect the fee structure and incentives being provided (causing news organizations like NYTimes to dismiss them as totally unrealistic).  I don't really know what the goal of this site is.  If it is to attempt to create accurate odds, or measure whether a betting market can accurately predict events, then allowing users to opt in to an alternate model of payment that is not activity-based (such as a subscription) would certainly help.  If it is to make money or it has some other purpose, then maybe it doesn't matter.







I think the current structure works well if we assume the fundamental purpose of the enterprise is to get people to participate in the market for the long term (which diminishes the burden of the withdrawal fee relative to a subscription or transaction fee), and to ultimately commit to an actual prediction. 


For example, right now I have a trade set up that works out to a 1.2% profit (after profit fees) in the most likely outcome, and between a .5% and -.5% result for the rest of the non-extraordinary outcomes. So it's roughly as good as a mediocre bank account.

But, if I'm willing to commit to a predicted outcome and unwind some of my hedges a bit early as the deciding event gets closer, the result improves dramatically - putting my likely (after profit fees) outcome somewhere in the +20% range. Assuming I'm right in deciding which hedges to unwind, of course. Which is the point of the whole enterprise - to get people to try really hard to be right.

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