This new exchange lets investors vote yes or no on major events to hedge their portfolios

A new exchange is trying to make it easier to hedge against events in politics and other areas.

Kalshi, a firm founded by Tarek Mansour and Luana Lopes Lara, was designated as a contract market by the Commodity Futures Trading Commission in late 2020 and officially launched in June.

The exchanges offers binary, yes-or-no contracts that pay out $1 if the investor makes the correct selection. Some of the current offerings include “will a recession start by Q2 2022” and “will income taxes on the highest income bracket increase by the end of 2021.” Traders are not allowed to use margin to take their positions.

In some ways, Kalshi looks like overseas betting markets that will sometimes gain popularity around key political events or even online sports betting, which has seen a boom of popularity in the U.S. in recent years. However, Mansour said the economic usefulness of hedging outcomes and Kalshi’s lack of a market maker role differentiates the firm from a casino.

“In casinos and gambling houses, the revenue they make is out of their customer’s losses. You get these weird incentives in the industry … for us, we take transaction fees. We don’t take money out of anyone’s losses,” Mansour said.

A big early test of the program came in November, when the company’s yes-or-no contract on whether Joe Biden would nominate a replacement for Jerome Powell at the Federal Reserve came into focus. 

Mansour said the market showed stability in the week’s leading up to President Joe Biden’s decision to keep the status quo at the top of the Fed.

“Some of the things we’ve seen with this Jerome Powell market is that, every time there was a piece of news such as Elizabeth Warren staunchly opposing Powell, or his trading activities were made public, the headlines were very sort of binary with respect to this forecast,” but the market didn’t show major knee-jerk volatility, Mansour said.  

After the contract was launched in September, the highest closing price for “yes” on the Powell replacement question was 32 cents.

“You could see a sort of constant adjustment to news but not an overshoot,” he said.

Kalshi’s team believes that the market contained both retail traders and more calculated hedging moves.

“I think we had a very good mix of people interested in this based on their portfolios and those more on the speculative side,” Lopes Lara said. 

The company does not have any formal standing with the Securities and Exchange Commission, but its current offerings are narrow enough that it should fall solely under the CFTC’s rules, according to Matthew Kluchenek, a partner at the law firm Mayer Brown. Kluchenek said the SEC could get involved if the contract market appears to be influencing securities prices in other markets.

To be sure, Kalshi is not big enough for professional investors to truly hedge massive portfolios. The Powell contract had total volume of about 227,000 total contracts before expiration, putting it on the level of a daily volume of a many small or midcap stocks. Additionally, there is a downside limit of $25,000 on individual contracts, though Mansour said that would be hiked in the near future. 

Overall, the exchange saw weekly volume of about 1 million contracts in November. The co-founders said the company expects major growth early next year as the exchange becomes more accessible.

“The plan for Q1 2022 is really to get out of beta,” Lopes Lara said. 

The next steps for Kalshi include launching a mobile app, expanding the trading possibilities beyond the company’s website.

Additionally, Mansour said the company has had discussions with brokerage firms about adding Kalshi to their listings and with other investment firms about serving as market makers on the exchange. Currently, orders on Kalshi sit on the books until another trader agrees to take the opposite side of the contract, which could lead to lower volumes and liquidity than if a market maker was involved.