I'll note that the article doesn't have a giant box for the combined value of all insurance policies, maybe because it's obvious that having $100,000 liability policy for your car insurance doesn't sound technical and scary like "derivative."

What blows my mind is that it seems like everyone in the media has taken this obviously incorrect premise and run with it.

The problem with derivatives is that they are functionally very similar or identical to insurance. But, because they are sold under a different name, the capital requirements for selling insurance do not apply. Insurance is less scary for a reason. Higher capital requirements, and less concentration of risk, means that insurance can't blow up the world economy.

This is not what's happening though AFAIK. In the lottery illustration there will be a single payout. In derivatives the risk of default for a certain "class" is treated as IID, and banks can leverage a certain amount on different risk classes (100x is not unusual).

But as 2007 demonstrated the real world risk is not IID. And at 100x leverage a 1% movement can totally wipe out a bank.

Also it's not like the 2007 crisis was fixed in any meaningful way. The FED just bought 1.4 trillion of MBS derivatives and is now sitting on them, actual value still unclear. Probably to be paid by the tax payer through 20 years of austerity.

But this has nothing to do with notional value. The world wouldn't be safer if we rewrote all contracts saying "1% on a notional amount of $100M" with "1M% on a notional amount of $100".

That's not a market at all. That's a $198,000,000 giveaway.

Well, not quite -- if odds of winning are in fact around 1 in 200MM or less, there is no market failure here.

Their point would still stand if they sold 100MM tickets though, so as not to confuse the two issues (ie. the notional amount and the expected value), perhaps it would have been a better example that way.

Only if someone is guaranteed to win the big prize.

In a one-off lottery scheme, the jackpot of a lottery should be less than or equal to the value of all of the contributions.

Did you introduce a central bank into the example some point? Is this a repeated game? Am I missing something? If not, this reddit comment makes no sense whatsoever.

You're assuming someone has to win.