00:00I do have to ask you about this margin request that the CEO of Kalshi put out yesterday.
00:06Why do we need margin on prediction contracts?
00:08Yeah, so the first thing is that this is a request for approval.
00:11So the agency, the CFTC, gets to approve this or review it to ensure that it's done appropriately.
00:18Secondly, if you think about prediction markets as an opportunity to hedge risk
00:23and the ability to take an insurance product to some degree out on an event,
00:28you're really looking at that as kind of a tail risk outcome,
00:31which means that the other side of that trade, the market maker, is fully funding 95% of the value
00:38of that contract.
00:39That's a lot of capital to tie up, right?
00:42So if we're adding margin to this, and this is an institutionally driven product, right?
00:47There are capital requirements.
00:49There's an application process.
00:50It's done very conservatively.
00:52It's not being done on sports, on culture, on what people will say, like you had just described.
00:58So this is really targeted at products that have an economic focus that are very well understood
01:06and that institutional traders have an expertise.
01:09Is this the idea is to bring more institutional activity to the platform?
01:13Are the institutions asking for this, or is it just something that Cauchy is putting out there,
01:17hoping that it can lure them?
01:18The institutions have asked for this for a long time, and because of the expensive cost of capital,
01:24of fully funding, fully collateralizing event contracts, this will incentivize them to participate more,
01:30provide more liquidity for those smaller risk managers that need these contracts for their hedging purposes.
01:35The market mention thing, though, wasn't in Tarek's proposal.
01:39Was that specifically carved out because maybe they knew that the CFTC was having some issues with it?
01:44No, I think, well, first of all, when the CFTC put out its advisory last night,
01:50none of the things that were listed no longer apply to contracts that Cauchy offers.
01:56Cauchy has taken those contracts down a long time ago, so these apply to other platforms.
02:02We'll see if they apply to overseas platforms that may or may not be accessing U.S. customers.
02:06I think that's an open question.
02:08But for the time being, this is something that is good for the industry.
02:13It's the agency using its guidance authority in a constructive way,
02:17as opposed to its enforcement authority and not telling the market what it's thinking.
02:22So it's a good step.
02:23There's been a lot of discussion at this conference about the evolution of prediction markets.
02:27One concern, at least in terms of the idea of protecting the integrity of markets overall,
02:32is this idea of insiders maybe using Cauchy, Polymarket, and some of the other prediction markets
02:37in a way that they wouldn't be able to necessarily use, you know, an IC or a traditional exchange.
02:43How is Cauchy internally trying to address that issue to make sure that there is a level playing field, so
02:49to speak?
02:50Yeah, so first, I think it's important to step back and understand what insider trading actually is, right?
02:56It's misappropriating information over which you have a duty to someone else or to a business or to an employer.
03:02It's not necessarily knowing something else that no one else does, right?
03:06That's a, you know, longstanding function for fundamental research in the financial markets to make them more efficient.
03:13But to that point, if there are people that could trade in event contracts on Cauchy
03:18that would be misappropriating information for their own benefit, Cauchy preactively screens them,
03:24precludes them from trading.
03:26It is the only exchange in the world that prevents someone from insider trading before they do it.
03:31Now, there always has to be room for after-the-fact enforcement.
03:34So we are seeing some cases being referred to the CFTC,
03:37and they are handling some of those after the fact, and I think that that's appropriate as well.
03:41How many cases have been referred to the CFTC by Cauchy?
03:44Well, I think we've heard of, you know, four or five, but there are dozens now that are being referred.
03:49And I think, you know, we can talk about market integrity and think that that's how, you know,
03:54here's an opportunity for people to actually profit.
03:57There's a flip side of that, which is that the more of these cases come to light,
04:01I think the more prophylactic benefit it has, the more it shows people that they can't do this,
04:06they can't get away with it, they're going to be caught.
04:07I do have to ask you about the whole sportsbook controversy.
04:11Obviously, the Third Circuit basically said federally regulated swaps in terms of what Cauchy is doing.
04:18The Ninth Circuit basically said, no, the states should be in charge of that.
04:22Is this now in the hands of the Supreme Court?
04:24Well, it's going to get there.
04:26You know, some parties have appealed both decisions to the Supreme Court.
04:29Are you, is Cauchy petitioning to take this to a Supreme Court review?
04:33Not yet.
04:33Cauchy has asked for the Ninth Circuit to review this en banc.
04:37You know, so for the full slate of judges to review it.
04:40I think that there may be time for some more ripening of certain arguments and certain cases to come up
04:45to the appellate level.
04:46But I do believe the Supreme Court is going to take this on, you know, possibly this term, most likely
04:51next term.
04:54And that's the appropriate thing to happen.
04:56You know, when you have arguments this strong and this severe,
04:59I do believe that there is federal preemption over contracts traded on regulated national derivative markets.
05:06Does Cauchy need to win at the federal level, meaning getting a ruling that sort of determines that the federal
05:11blanket applies rather than the state in order for their business to continue,
05:15at least on the sports book side of this, on the sports contract side?
05:18Well, if the Supreme Court ultimately ruled that sports contracts as currently offered could only be offered by state regulated
05:26casinos,
05:27then that would obviously mean that Cauchy can no longer list them.
05:30But I think there's a middle of the road outcome here,
05:33which is that states can regulate their casinos the way they want.
05:36And the federal government, the CFTC, can regulate their derivatives markets the way they want.
05:39And I think that's a good thing because they're different business models and they pose different risks.
Comments