When it was founded, Kalshi was billed as a new gambling site that allowed users to bet on yes or no questions. However, that’s incorrect. Kalshi developed a new type of financial asset that has attracted the interest of hedge funds, market makers, and brokers. They’ve created event contracts that allow users to hedge their risks on real-world events. Event contracts are yes or no questions priced between one cent and 99 cents. If users guess the outcome correctly, then they’re paid $1. If they’re wrong, then they get nothing. Kalshi is the financial exchange that hosts these trades.
Even though Kalshi is a financial exchange, gamblers and bettors are attracted to the platform. They may use it as a gambling platform even though that’s not what it’s designed for. We reached out to Kalshi CEO, Tarek Mansour, to understand the role those customer segments play in their exchange and how Kalshi actually works now that it’s live.
Kalshi’s Beta Launch
On July 26, 2021, Kalshi launched its live beta. The financial exchange dedicated to event contracts was ready for use. Kalshi was prepared for many people to be interested in the exchange. But the high rate of engagement on the platform remained a surprise.
“The engagement is definitely higher than we expected,” said Kalshi CEO, Tarek Mansour. “People are trading 10x more a week than we initially thought they would. So, people have been waiting for the product, especially in a regulated way.”
The Kalshi exchange is easy to understand and navigate. But those are only some of the things that make it accessible to a wide audience. Kalshi is a financial exchange regulated by the CFTC. With large amounts of oversight and legitimacy conferred by the CFTC, Kalshi is a safe option for speculators and hedgers alike.
“More people really see this as a proper asset class,” said Mansour. “They can trust it. They can properly trade it the same way you trade stocks, commodities, equity, versus if they go to an unregulated betting site where they might be less inclined to use it or put substantial money on it.”
Surprisingly Popular Markets
Kalshi offers event contracts on many different topics. Those topics include politics, economics, and COVID-19. But there’s one category that has become surprisingly popular.
“I think some of the markets that we expected a bit less volume than they’re currently trading are things like the weather,” said Mansour. “There’s a lot of interest there. So, we have daily weather markets that people trade on.”
But upon reflection, maybe it’s not a surprise that this seemingly mundane topic is such a hit with Kalshi traders. Kalshi’s founding principle is that users should be able to hedge risks on events that affect their lives. Most of the time, the weather isn’t a noteworthy part of peoples’ lives. However, it can become an immediate and life-changing concern and justify entire weather markets. Hurricane Ida, which devastated New York and the northeastern United States, is a good example of why users are drawn to markets that feature weather predictions.
“They were living it,” said Mansour. “Floods are in the news and [people] are stressing about them. This is where their minds were and so this is where their trade was as well.”
Kalshi saw increased interest in the weather markets during Hurricane Ida because that was what was on users’ minds. Event contracts on Hurricane Ida were not only ways for users to make their own predictions about what they were going through. They were also ways to make a little money in the wake of that disaster to cushion the financial impact of the storm. There are different ways for users to make money in the wake of disasters like Hurricane Ida. They run the gamut between risk-seeking and risk-avoiding.
Hedgers And Speculators
At the time of this writing, Kalshi’s beta has only been live for a little over a month. However, it’s already seeing distinct types of customers emerge with unique trading patterns. Traders are on a spectrum between low-risk hedgers and high-risk speculators. The hedgers are on Kalshi to minimize risks and only make calculated ones if they must take them at all.
In contrast, speculators are taking the unpopular positions in the hopes of reaping high rewards. If a user buys 100 event contracts at 1 cent each, they can make $100 on $1 of investments. Add a few zeroes to that initial investment, and the rewards become mouth-watering. However, the odds of them being right are astronomically low. So, it takes a unique personality to put money on the grossly unpopular side of an event contract.
Gamblers On Financial Exchanges
However, speculators and gamblers looking to use Kalshi as a gambling platform overlap with each other. Speculators are high-risk traders while gamblers leave their winnings to chance–even if they believe they don’t. Concerns about gamblers improperly using financial exchanges to gamble go as far back as 1905. A case about whether grain futures were constitutional went to the Supreme Court. Justice Holmes reasoned that gamblers on exchanges were an ineradicable problem. But that was not a reason to outlaw financial exchanges or speculative investments. Speculators are critical to healthy financial markets.
“Without speculators, you cannot build a marketplace,” said Mansour. “We cannot build a marketplace purely out of hedgers. We need people that are taking the other side of the trade and taking liquidity. And those people are being compensated for taking the other side of the trade or providing liquidity by potentially making more money if they are in the money.”
Although the platform is built for hedgers, hedgers wouldn’t be able to use Kalshi without speculators. Even though Kalshi is not a gambling platform, gamblers who try to use it as one play a crucial role. Especially when they take high-risk positions, like buying one-cent contracts when 99% of the market believes the outcome will be a resounding yes. Without the crazy risk-seekers, there’s no low-risk side of the trade for hedgers to hedge on.
Kalshi Trading Strategies
While few bettors are well-versed–or versed–in derivatives trading, there are a few things they can learn to pick it up intelligently. There are a few things that users can look for in Kalshi’s event markets to find opportunities for large gains that many users may be missing. However, there are safe investment strategies, too. If users understand spreads, they can understand why low-risk traders may turn to an extreme strategy like yield-farming.
Spreads: Opportunities For Rewarding Risks
Most of Kalshi’s markets close out with 99 cents on one side of the trade and one cent on the other. Besides the event contract prices, they’re also fair reflections of the probabilities that users assign to an event happening or not. Usually, these prices add up to a clean $1. However, sometimes the prices are something like 38 cents and 64 cents. That adds up to $1.02, which seems like it violates some probability rule. That extra two cents is called a spread, and it’s not a broken rule or a built-in house advantage analogous to a sportsbook’s house advantage. Instead, it’s a healthy market feature.
“The market makers always leave a spread there because that’s how they’re compensated,” said Mansour. “They take any side. [They’ll buy a] yes at 36 [cents], they’ll take a side of no at 62 [cents]. The two cents is what they get as compensation for basically providing liquidity to the marketplace.”
However, spreads can reach as high as five cents. That often comes from uncertainty in the market. That’s when traders aren’t sure what the chances of an event occurring are. Wide spreads narrow as traders become more certain of the chances of an outcome.
In short, spreads come from market makers and from uncertainty in the market. However, the uncertainty piece is more important for speculators. If speculators can buy an uncertain outcome at a low price, they could come out ahead if the rest of the market decides that the previously unpopular position was the correct one. However, there’s no guarantee that it’ll work. It’s just a potential opportunity. Speculators can’t use non-public information to tilt the odds in their favor, either. Insider trading is as illegal on Kalshi as it is on the New York Stock Exchange.
Yield-Farming: Extreme Caution
The other end of the spectrum from taking advantage of volatile markets is reaping the slow rewards of small but safe investments. Yield-farming is when traders buy event contracts at 99 cents and get their $1 payouts. It’s a 1% return, so it’s unattractive. It’s also ridiculously expensive if something crazy happens and the 99% are wrong. But in a market with low spread and consensus, yield-farming is a strategy that risk-averse traders can take advantage of.
That’s also one of the things that set Kalshi apart from sportsbooks or similar gambling sites. Kalshi doesn’t have a house advantage. It only charges transaction fees. So, even a trading strategy like yield-farming that seems to take advantage of the Kalshi exchange is a legitimate strategy. Kalshi doesn’t lose money if investors earn money. In contrast, arbitrage betting eats into sportsbooks’ profits and can get bettors banned one sportsbook at a time.
That’s why it’s unwise to equate Kalshi with a gambling site. Traders can “win” on Kalshi without fighting against Kalshi. Sportsbook users have to take what they can get from their sportsbooks.
How Kalshi Pays Its Traders
Because Kalshi is regulated by the CFTC, Kalshi’s payouts are scrutinized and controlled. There are a few steps to securing Kalshi’s payout money and paying it out. But despite the controls and oversight, it’s a simple payout system.
“When you take a position on a market, you have to pre-fund your position,” said Mansour. “We take the collateral and we’ll put it in a member-segregated account.” So, the money that traders put into a market goes straight into a special bank account. That account is overseen by the CFTC and cannot be touched by Kalshi or by the CFTC. “That account is completely protected,” said Mansour.
It’s also worth remembering that there’s someone else on the other side of the trade that provides the other part of the dollar. “If Chris is buying [yes] at 60 cents and someone else is buying the no at 40 cents, we’re taking the 60 cents from [Chris], the 40 cents from the other person to get the full dollar per contract and pay it out to whoever was in the money when settlement happens,” said Mansour. So, the money is protected, overseen, and sustainable.
There are a few things that Kalshi would like to add to its exchange to reach a wider range of traders. They’d like to offer more event contracts in response to news stories since that’s another way that users become interested in certain markets. They’d also like to expand their list of distribution partners. For example, they’d like to partner with brokers so brokers can offer event contracts to their clients alongside stocks, bonds, and other assets. But ultimately, the goal is to increase liquidity and volume. That means more money in the exchange and more trades in the markets.
But this is all part of an organic process of growth that Kalshi seems to be embracing. Even though Kalshi will transition out of its beta phase, it hasn’t brought a half-done product to market. It’s open for trading to anyone who’s interested. But the next steps will revolve around scaling and expansion. That means increased liquidity, which is more money in the Kalshi exchange. “Most great companies that are exchanges build liquidity incrementally,” said Mansour. “It’s always about that marginal percentage increase every month that gets you to the big multiplier effects down the line.”