How Prediction Markets are Stretching Regulatory Categories

The emergence of prediction markets could be one of the most disruptive innovations our industry has seen in recent years. One of the reasons for this is that they possess so many of the ingredients that financial services businesses value when attempting to make a bid for mass appeal.  

They’re simple to understand, don’t preclude involvement from non-traders, and don’t require costly campaigns to educate users. In many ways, this is the holy grail for trading businesses: a financial product without a steep learning curve that effectively sells itself. 

The fact that they cover such a vast array of topics, from politics and popular culture to sporting events, means that almost anyone can find at least one of their personal interests represented. And because they’re based on the areas of daily life that people spend so much of their time on, there will never be a shortage of popular outcomes to trade.  

This is the genius of events-based trading from a marketing standpoint. The events themselves, be they elections or boxing matches, bring with them their own captive audiences. Prediction markets just leverage this interest by offering a unique way for followers and fans to potentially profit from their opinions.   

What’s particularly intriguing about them is that they sit at the crossroads between finance and gaming. This means they attract customers from both worlds, as well as entirely new consumers who may not be the target market for either.  

This is why businesses on both sides of that traditional divide are currently scrambling to gain a foothold in events-based trading. They see where the trend is heading and are eager to step outside of their respective domains to secure a piece of a market that’s expected to generate tremendous upside.  

Below, we focus on this nexus between finance and gaming from a regulatory standpoint. Using the US as a test case, we explore how the oversight of prediction markets is evolving, and how they’re throwing existing regulatory classifications into question.  

If you’re new to prediction markets, you may find our introduction to events-based trading useful. If you’re interested in offering prediction markets to your own clients, we also have a prediction markets solution for you. 

A softer regulatory stance 

Under the current US administration, US regulators have relaxed their typical hostility toward financial innovations such as crypto and prediction markets. In February of this year, the SEC dismissed its actions against Coinbase, Binance, and Gemini and ended its investigation into Robinhood Crypto. In March, it dropped its enforcement action against Kraken.  

This is relevant to events-based trading, as prediction markets initially gained ground in the unregulated Web3 environment, with projects like Augur, Gnosis, and Polymarket as trailblazers in the space.  

As regulatory constraints have relaxed, we’ve seen firms like Coinbase, Kraken, Gemini, and Robinhood all moving to offer prediction markets, while crypto native projects like Polymarket have pivoted toward regulatory compliance in order to offer their prediction market services to US clients legally.  

This is in stark contrast to the situation just a few years ago, when Polymarket was banned from operating in the US by the CFTC. The following year, the regulator also banned Kalshi, Polymarket’s biggest competitor, from running prediction markets on political outcomes.  

Since then, Polymarket has been able to re-enter the US market by acquiring a CFTC-licensed exchange and clearinghouse. Kalshi, on the other hand, went on the offensive, suing the CFTC following its ban. Kalshi subsequently won its case at the end of 2024.

The changing regulatory climate offers a path that can be pursued by interested firms seeking to launch their own prediction market services.

CFTC classification 

The CFTC’s move to assume responsibility for prediction markets has been viewed as a tacit green light for prediction market businesses seeking to operate in the US.  

When the CFTC banned Polymarket from offering its services to US clients, it did so under the assumption that events-based markets are “composed of a pair of binary options, constitute swaps under the CFTC’s jurisdiction, and therefore can only be offered on a registered exchange in accordance with the CEA and CFTC regulations.”   

This statement points to a clear distinction between prediction markets and gambling products. While sportsbook wagers are one-off bets made with “the house,” events-based trading is much more like a financial derivative in that each event is a market that’s created by buyers and sellers, in which the price is set by demand on either side of the outcome, or lack thereof.  

In addition, similar to other derivatives like futures and options, these contracts, which also fluctuate in price as they drift closer to resolution, can be resold to other traders before they expire. 

Federal vs state regulation  

While the CFTC has carved out a path for prediction markets businesses at the federal level, there’s still some confusion at the state level due to the fact that some state gaming regulators view prediction markets as overlapping with their own regulatory responsibilities.  

In the United States, financial markets are regulated at the federal level by bodies such as the SEC and the CFTC. Gaming, on the other hand, is regulated at the state level, which is why different states have different gaming laws, with sportsbooks still not legal in many US states, such as California and Texas. 

The enormous commercial potential of prediction markets, combined with the fact that they allow people to gain exposure to sporting outcomes, has led to tensions emerging between federal and state regulations.  

Currently, there are two broad types of businesses seeking to gain a foothold in the space. On the one hand, there are financial services firms, brokers, and exchanges, which view prediction markets as a new kind of instrument that’s particularly attractive to retail traders.  

On the other hand, there are established sportsbook businesses that are also aware of the huge potential of this nascent market, but view prediction markets as an expansion of their own current business models. Most importantly, these businesses see prediction markets as a way to gain access to customers in states where they are currently not permitted to offer sports betting.  

This is where the tension lies. The brokers and exchanges, like Robinhood and Coinbase, that are entering the prediction markets business have no dog in this particular regulatory race, as they have always been regulated at the federal level.  

It’s the gaming businesses entering the space that are currently caught up in state-level regulatory spats with the bodies that have traditionally been responsible for overseeing their activities.    

This came to a head recently when the New York State Gaming Commission announced that it would be reviewing whether existing license holders that are adding prediction markets to their offerings are “unfit to maintain their gaming license.” Nevada, Arizona, and Ohio have also warned businesses operating in their jurisdictions that offering prediction markets in other states could potentially be a breach of local regulations.   

As a result, both FanDuel and DraftKings, two of the largest sportsbook providers in the US, have recently decided to exit Nevada while they pursue their expansion into events-based trading at a national level. DraftKings acquired Designated Contract Maker (DCM), Railbird, in October of this year, while FanDuel recently announced its partnership with CME Group.  

Before the dust settles 

Who could have predicted the sheer novelty of betting operators attaining CFTC licenses a few years ago? Beyond this, we’re witnessing a fascinating moment in regulatory history where a new instrument is effectively busting old categories.   

The combination of regulatory tailwinds at the federal level, huge commercial potential, and widespread interest from the business community is leading to an atmosphere of expectation. It seems that all parties are expecting prediction markets to take off, and this is why so many parties from different areas are bidding to control a share of this new market.  

This includes the state gaming regulators, who are starting to kick up a fuss. They appear to be taking exception to the fact that CFTC regulation is effectively bypassing their own authority, rather than having anything against prediction markets in their own right.  

Compare this situation to the crypto businesses of old that operated in regulatory opacity or outright hostility for decades, and it’s clear that much has changed, at least under the present administration. 

The best way to describe what’s currently taking place is a mad dash for market share before the dust settles. Why else would sportsbook businesses be willing to throw their existing licenses into question, if not for the potential of a much broader national market? To say nothing of the fact that these businesses will get to build a client base in states where they’re not currently permitted to operate, with a view to converting these customers at a later date, should sportsbooks become legal in more states across the US. 

On the other side, we’re seeing traditional trading businesses investing heavily in a form of trading that’s only tangentially financial. The CFTC makes a convincing case, in principle, that prediction markets essentially boil down to a pair of binary options (one on the “yes” side of an outcome and one on the “no” side). 

However, it’s difficult to reconcile a market on whether Ariana Grande will have a number 1 album again this year with the kinds of trades traditionally offered by brokers and exchanges. Unless, of course, the old categories are now becoming insufficient, which increasingly seems to be the case.