When Tarek Mansour was an equity derivatives intern at Goldman Sachs in 2016, he thought there had to be an easier and less expensive way for investors and businesses to hedge their risks. At the time, institutions were scrambling to hedge the implications of Brexit.
Investment banks can create complex structured instruments that align with these types of risks, but they are rarely an exact fit.
“Institutions are buying expensive, complex products, which don’t exactly correlate to what they want,” Mansour said. “Why isn’t there an exchange where the underlying itself is the event, because events are tangible to all of us?”
So when Mansour, who was born in Lebanon, graduated from Massachusetts Institute of Technology in 2018, he and his co-founder Luana Lopes Lara, who has a master’s in CS from MIT, decided to start their own exchange. Called Kalshi, it’s the first federally regulated exchange where participants can trade on the outcome of geopolitical events around the world or on local issues such as whether indoor dining in restaurants will be shut down in New York City. The contracts are all answered with a "yes” or “no.” The exchange is aimed at institutional and retail investors, as well as small business owners, like restaurant owners, that want to hedge certain risks.
“Whether you’re looking to get exposure to an event or hedging against that event, today the only way to do it is through indirect proxies, or things that align with what you’re hoping to do. But a lot of that initial risk comes from a specific event. We’re allowing these people to take all those beliefs, all those worries, or needs for hedging and turn them into a specific trade with a simple intuitive product,” said Mansour, who studied electrical engineering, computer science, and math at MIT.
According to Mansour, what he’s doing isn’t necessarily a new idea.
He said the event contracts are a natural outgrowth of the development of grain futures 200 years ago to address the risks facing farmers. Derivatives then evolved to include metals, commodities, oil, and more intangible risks. Interest rate swaps emerged 20 years ago and have since turned into a $500 trillion business.
“Today individuals and institutions are exposed to climate, weather, Covid, geopolitical events, economic events, and others,” Mansour said. “So that’s where the core of the idea came from: to build a general-purpose exchange for people to get direct exposure or hedge themselves directly against the outcomes of those events.”
It might not be a new idea, but Kalshi is the first focused exchange to be recognized by a federal regulator. The regulatory due diligence process for the exchange, which is now being “beta” tested, started in 2019. Kalshi’s event contracts are are all pre-funded by participants. If a participant wants to buy a $1 million contract, they have to have that exact amount in a Kalshi account.
One pension fund CIO said he’s closely watching the development of these contracts and said the market could use an innovator willing to address issues like costs. While he doesn’t think his fund will be an early adopter of the event contracts, he said the products are similar enough to other futures and options that it would be easy to incorporate them into the portfolio at a future point in time.
Ali Partovi, CEO of venture capital firm Neo, backed Kalshi because he believed the two founders would do what they had to do to get regulatory approval.
“Twenty years ago, I started thinking about the idea of investing directly on the outcome of events, but mostly as a fun exercise,” he said, noting the challenge of getting regulators on board.
There have been other start-ups that have tried to do something similar and failed. But Kalshi has a different approach, Partovi said. “They respect and have deference for the regulatory framework,” he said.
Mansour said the exchange will ultimately become a unique central data source and place to see how opinions are changing.
“These markets are a little like an aggregator of public opinion in real time,” he said. “How would we be able to forecast the outcome of a geopolitical event? Usually, you poll people for their opinions, but the polls aren’t precise because people can say anything. With Kalshi, people have to put money on their opinions, which likely makes them a lot more truthful. Then there is the weighing mechanism the market does. That’s what markets are so great at; they give you a really accurate forecast.”
As an example, Mansour pointed to one of the contracts now available: “Will Indoor Dining Shut Down in New York?”
When the market was opened this summer, people were trying to return to their normal lives. Through July 15, the contract, “Yes, indoor dining would close again,” was priced very low at around 2 cents; “No, indoor dining would not close again” was priced at 98 cents. “By July 23, people thought it was much more likely that indoor dining would close again as talk of the Delta variant in the U.S. picked up — ‘Yes’ was then priced at 26 cents. Since then, the price of ‘Yes’ has gone back down again,” he said.
Other questions on the exchange include: Will the Consumer Price Index increase more than 0.4 percent in August? Will a recession start this year? Will the debt ceiling be raised or suspended before October 1? Will the unemployment rate be above 5.3 percent in August?
“Today, there are so many weird risks that companies face, whether Covid or related to politics,” Partovi said. “There’s so much more uncertainty and volatility in the world. One hundred years ago, most volatility hinged on things related to farming. So commodity futures on corn would address the biggest risks. But the economy is so diverse today, that doesn’t work.”
