When we wrote about Kalshi for the first time, we wrote about an investment company that would let traders put money on yes or no questions. But Kalshi’s exchange does more than that. The yes/no questions aren’t just a novelty. They’re simple solutions to a problem that most people probably don’t about. But many innovative startup ideas look that way in hindsight.
While putting money on yes/no questions is headline-catching, it misses Kalshi’s potential impact on the finance industry. Kalshi has created an exchange that gives companies new ways to hedge risk. The details are complex, but the idea is simple. Kalshi took a financial security that was expensive, complex, and narrowly available, then made it cheap, simple, and widely available.
We spoke to Tarek Mansour, CEO of Kalshi, to dive into the details of what the company does, why it’s useful, and why comparing the company to sportsbooks is facile.
What Kalshi Is For
We talked about what Kalshi does in our last article about the company. Kalshi offers an exchange where investors can trade stakes in yes or no questions. But Tarek Mansour drew us the big picture to help us understand these yes/no questions’ significance.
“The idea with Kalshi is event risks are not limited to big institutions,” said Mansour. “Everybody has risk. We’ve seen the impact of COVID in the past year, the impact of Brexit on people and businesses. We’re developing a simple and direct asset class for people to [hedge] those event risks that they face in their day to day.”
There are lots of things that could mess with companies’ financial performance. A natural disaster could wipe out a plant or a trade war could ruin pricing plans. However, companies can invest in derivatives to hedge some of their risk. Derivatives are financial securities that get their values from some price changes in another asset. For example, an agricultural company could invest in grain derivatives. The value of grain could plummet, but the derivatives’ values would still have value. The agricultural company could use its derivatives to get some cash and cushion the blow from an otherwise devastating financial loss.
However, there wasn’t an asset that could protect a company from disruptions caused by something like Brexit or COVID-19. Few large companies could afford the types of convoluted securities that would insulate them from a Brexit or a plague. But Kalshi’s yes/no questions provide those tools.
Putting money on yes/no questions doesn’t seem so gimmicky now, does it?
How We Got These Crazy Financial Tools
Derivatives used to be obscure financial tools used by farmers. Since those early days, farms continue to use them. But the derivatives market has spawned many new types of derivatives, too.
One of the reasons bread is so cheap is because farmers can invest in derivatives as they work. Farmers don’t gouge bakers for wheat, grain, or flour. Instead, farmers use these financial instruments to create cash cushions for themselves. That takes care of their rainy-day funds and lets them charge lower prices to bakers.
Farmers used derivatives first. Then derivatives were created for other things like metals, which gave manufacturing companies room to breathe. Investment firms eventually gained access to derivatives to ease the burden of a portfolio company going under. Tarek Mansour sees event contracts as the next step.
“We see event contracts as a new asset class that is the next step in this evolution,” said Mansour.
These new event contracts will let professional investors and amateur traders hedge risk on many events. They’ll also be able to hedge their financial risks with a comparatively approachable trading option.
Getting Started With Event Contract Trading
It’s not enough to know that they can give investors a cushion if some big event disrupts their money. Knowing how to realize that gain is important. Since event contracts are so new, traders may not know how to trade them. But Kalshi has an education center that gives traders the essential tools for event contract trading. Current topics include:
- Working with event contracts
- Trading successfully
- Fitting contracts into investor portfolios
This list of topics will likely expand. But it illustrates the foundation that Kalshi wants to build for its customers. With the written guides, Kalshi is determined to prepare its customers to create their own investment strategies. Remember, Kalshi just offers the exchange and provides guidance to get started. Investors must figure out how to use event contracts for themselves.
Expected Rate Of Return
Savvy investors (and sports bettors) may already be wondering what kind of returns they can get from trading event contracts. However, that’s not really what they’re for. Kalshi is an exchange. Investors are meant to use it to hedge risk, which doesn’t promise a return. In fact, investors may incur a cost to alleviate pressure from other parts of their portfolios.
Amateur investors and gamblers may try event contract trading. But if they do, then it’s up to them to discover a profitable trading strategy. Kalshi provides the exchange, but they can’t tell traders how to game it. They certainly don’t promise a certain rate of return.
While there may be some trading strategies that prove profitable for individual traders, that’s not the primary purpose of event contracts. They’re primarily for investors to manage portfolio risk rather than reap massive returns from.
A Concrete Example With Brexit
All this information can sound confusing without a concrete example. So, Tarek Mansour offered this example of how a portfolio manager would use Kalshi to guard against whatever damage Brexit might do to the manager’s portfolio.
“For instance, you may have a portfolio of equities, commodities, and a number of different things,” said Mansour. “And you’re worried about a specific event that is coming, like Brexit, for example. You don’t know the impact that it’s going to have on your portfolio exactly. So now [you] could buy event contracts with respect to [whether] Brexit [will] happen this year to mitigate that risk. You would be able to take out risk from [your] portfolio and not have it adversely impact the portfolio more broadly.”
That’s the theory behind the trade. But here’s how it would look with hard numbers.
Each ‘yes’ contract pays out $1 if the event happens and $0 if it doesn’t. Traders can buy an event contract at any price in between. So, traders could buy an event contract at $0.40. Some people might hang onto it until it cashes out. Or, traders could wait for the market to move and sell their event contracts off at $0.70.
So, traders can buy several contracts on the same event, the same way stock traders can buy multiple shares of stock from the same company. Then they can either:
- Hold onto the contracts until they cash out.
- Sell the contracts off depending on cash needs or market fluctuations.
Those are the two paths traders can use to develop investment strategies for event contract trading.
Kalshi Regulations
We’ve uncovered the details about how event contract trading will work. However, the laws regulating Kalshi reinforce its role as a fair marketplace. This came up when we asked Tarek Mansour about laws against market manipulation.
“We’re regulated by the [Commodity Futures Trading Commission,]” said Mansour. “The CFTC has a set of 23 core principles and you alluded to core principle three–markets are not susceptible to manipulation–which is one of them. So, there are core principles that we must follow as an exchange that has integrity–and protects our customers.”
Kalshi also has surveillance measures in place to ensure its exchange doesn’t become a cesspool of fraud.
“We do trade surveillance and profiling where we’re constantly monitoring our markets for some of the activities that you mentioned, like market manipulation, spoofing, wash trading or other things that can happen on exchanges like the CME or NYSE,” said Mansour.
If these surveillance measures detect users attempting to commit fraud, penalties can range from fines to criminal prosecution. Gaming a financial exchange isn’t like gaming a sportsbook through arbitrage betting. Committing fraud on Kalshi is a criminal offense. But that’s far from the only difference between Kalshi and sportsbooks.
Why Kalshi Is Not A Gambling Platform
It’s easy to slip into saying Kalshi lets users bet on the outcome of yes or no questions. But that wouldn’t be a fair representation of what Kalshi does or what its purpose is. Kalshi offers a risk-mitigation tool that investors can use to take the pressure off other areas of their portfolios. In contrast, sportsbooks offer an entertainment product and an understood gamble.
The most significant difference is how prices are set. Kalshi’s platforms will let the free market decide event contract prices. Sportsbooks adjust their prices to ensure the company is profitable. If a financial company did this, it would be market manipulation. It’s not because they’re the same companies operating under different rules. It’s because the foundations of these companies are completely different. Kalshi makes money from transaction fees. Sportsbooks make money by collecting bettor losses and adjusting odds with their bottom lines in mind. Kalshi offers an investment tool. Sportsbooks offer an entertainment product.
We normally cover gambling companies. However, understanding the difference between gaming companies and cynical perceptions of financial companies is critical to understanding the gaming industry. It’ll help bettors understand how their sportsbooks profit off them and how these businesses can scale. It should also remind bettors that a career as a professional gambler is probably not a viable one. (Individual sports bettors who make $60,000 a season shouldn’t be idols. They can rake that much money in because they can play $600,000 a season and game the sportsbooks.)
Kalshi is set to launch soon, and we’ll watch it with great interest. It has a lot of promise, but it still has to execute its idea. We’re cautiously optimistic about Kalshi’s future, but we’re withholding gushing praise until after it survives the perilous high-growth phase.
And that’s still a long way off.
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