Incentives

The invisible hand that pushes people to act.

#Plain-English Definition

Incentives are the reasons we do things. In economics, the golden rule is: "People respond to incentives."

• Positive Incentive: "If you get this right, you win $100."
• Negative Incentive: "If you get this wrong, you lose $100."

#Designing Markets

Prediction markets are essentially Incentive Machines. They are designed to extract truth by paying people for it.

• To reveal information: We pay you if your information is correct.
• To provide liquidity: We offer fees or spreads to market makers.
• To govern honestly: We slash the stake of bad actors (in crypto systems).

#Misaligned Incentives

Problems arise when incentives point the wrong way.

• If a CEO gets a bonus for short-term stock price, they might sacrifice long-term health (Principal-Agent Problem).
• If a pollster gets paid for clicks, they might create sensational/outlier polls.

Prediction markets try to align incentives so that Truth = Profit.

#Key Takeaways

• "Show me the incentive, and I will show you the outcome." — Charlie Munger
• Prediction markets work because they align the incentive to be right with the incentive to make money.