People are gambling their savings account (safely!) with no-loss lotteries. ($17,000% returns!?)
The interesting behavioral economics behind prize-linked savings accounts.
Saving is hard. Seriously. The economic literature on this shows humans are especially bad at wanting things NOW not later. The technical term is “discount rate.” You may have heard of the most famous children’s study on discount rates- the marshmallow test.
If offered [insert thing you like] right now OR the same amount of the same thing at the same quality level but in the future- you’re probably already thinking, “well just give it to me now”.
$5 today or $5 in a few days? “Just give it to me now.”
$5 today or $10 in a few days? “I’ll see you later this week.”
This is called time preference. You have to be paid for the inconvenience of waiting. In my mind I think of it as a future-premium but some economist decided to invert the idea and it stuck. So instead of a future premium, the literature frames it as how much you would pay (in time) to have it now.
$10 in [X] days or $5 today? “I’ll take the $10 if [X] <= N”
Then depending on the maximum number of days you would find acceptable, it’s thrown into a function F($10 - $5, N) and we calculate your discount rate.
I’m oversimplifying a bit- the behavioral / neuroeconomics behind the human brain is cool stuff. People have wildly inconsistent time preferences with all kinds of interesting biases. You can read the hyperbolic discounting wiki if you’re interested in more on this.
To summarize the 2 points so far:
People have to be paid for the inconvenience of waiting.
The normalized way to measure how much a person needs to be paid for waiting is called the individual discount rates.
You can think of this as an “impatience” metric but try not to bring too much negative connotation to it. It’s just a metric and it’s often individual-product specific too. I don’t personally care about marshmallows.
High discount rates are associated with lower income. This makes sense, if you don’t have a lot of money you aren’t going to have the flexibility to make liquidity-risk-reward tradeoffs like certificate of deposits or 401ks (let alone liquidity pools). You need a minimum amount of emergency funds to really start investing. When you’re paycheck to paycheck, you literally can’t afford to wait.
So how do we get the best of both worlds? How do we get savings to be liquid enough for people with lower incomes (who are severely underexposed to interest bearing opportunities) to trust they can withdraw quickly in case of emergency (liquidity) AND generate the kinds of returns that make a meaningful financial impact for those investing small amounts? ($10 -> $11 is a candy bar; $10M -> $11M is a candy store).
Make savings a hobby!
With discord, telegram, twitter, and reddit there’s all kinds of communities talking about investing as entertainment / meme stocks / etc.
Generate disproportionate rewards that go viral to activate people’s internal gambler.
This may sound manipulative, because it is, but people love winning.
You may be thinking, “this sounds like a lottery… I thought we were trying to help people save more?”
We are! Not all lotteries have to have a negative expected value. Historically, lotteries were used for fundraising (the early US history on lotteries is an interesting read). People knew their odds were low but were willing to lose money (on average) because they trusted the funds went to good causes like infrastructure anyway.
These loss-lotteries extract money from participants. But no-loss lotteries (or prize-linked savings accounts) are a well known development economic tool with roots going back hundreds of years in some cultures.
The idea is simple: a group comes together at some frequency (say, weekly), they combine money, then each week the next person in rotation gets the pile of money. These are effectively 0% interest loans since you pay it back in pieces when it’s not your turn. But the lump sum can make investment, emergency expenditures, etc. much easier to handle.
What decentralized finance has done, is make it easier to make that 0% interest- not zero. A gain-lottery.
I don’t know the specifics of how PoolTogether does it, but here’s the rough idea:
People deposit money into a collective savings account.
The collective savings generates interest.
The interest earned is split into 2 pieces: 1 piece is added to the prize pool, the other piece is allocated to people proportionally based on their deposits.
Every so often, the prize pool piece is randomly given to a depositor (generally, the probability of winning will also be proportionate to the amounts deposited).
This gamification & social factor incentivizes savings among those with high discount rates. This generates a virtuous cycle of investment.
Now you may be thinking,
Isn’t this ultimately patient people paying impatient people to be more patient?
Technically- yes. But note, there’s positive externalities here. The more people participating, the more interest that’s being generated, the more savings/investments getting made, and the more you might randomly win!
That is to say- everyone benefits when we collectively become more economically patient.
This is also true in the macro-economic sense. In any economy there’s a fine balance between consumption and savings. Savings in an economy funds investment which improves economic efficiency and (should) lower the price (or raise the quality) of goods allowing us to consume more (or better) in the future.
But we need consumption today to keep the money in the economy flowing (in the form of people’s wages). One of the major drivers of wealth inequality is this fundamental inequality of consumption (measured by marginal propensity consume). If the economy is disproportionately driven by low income, high discount rate people spending nearly all their money- then savers are disproportionately high income, low discount rate people. Then the rich get richer.
No-loss lotteries / prize linked savings accounts are an algorithmic and non-governed way to redistribute the benefits of investments and make us all more economically patient.
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