Prediction Markets' Legal Case

Why prediction markets in America are likely to survive

Note: I am writing this at Manifest, a prediction markets conference hosted by Manifold Markets. Here, I’ve learned more about the legal situation surrounding prediction markets.

As I described in a recent post, bureaucrats at the CFTC (a federal agency) have officially proposed banning trading on elections, Academy Awards, Supreme Court decisions, and pretty much anything interesting.

Reacting to that post, Richard Hanania commented:

After talking with multiple prediction market founders this weekend, I’m pleased to report that legal theorists have already been working hard on this issue for several years, and we’ll soon learn if their approaches pay off. Here are their approaches, in more detail:

A federal judge just heard arguments in a lawsuit challenging the CFTC’s authority to ban election trading

The CFTC order justifies its proposed ban by calling election trading “gaming,” which is a questionable assertion. The bureaucrats call it gaming because the actual law they are supposed to enforce says that trading may not involve:

(I) activity that is unlawful under any Federal or State law;

(II) terrorism;

(III) assassination;

(IV) war;

(V) gaming; or

(VI) other similar activity

The CFTC says trading on elections amounts to “gaming” because it’s gambling. That’s off-base for two reasons:

1. The law establishes categories of trading that are forbidden, banning trading about terrorism, assassination, gaming, etc. The CFTC is wrongly interpreting the above law as forbidding gaming itself, and then declaring election trading to be gaming.

2. These markets don’t work like casino gaming or bookie odds. Rather, contracts are traded between buyers and sellers in a transparent way, just like trading works on stock exchanges. Yes, I created “ElectionBettingOdds.com”, because that’s more fun than, say, “ElectionTradingOdds.com” — but it’s betting in the same way that short-term trading on Telsa or Bitcoin or NVIDIA is gambling. In fact, many do gamble on the value of such companies, but we also recognize that it’s different from playing at a casino, because it’s formalized, fair, and provides valuable information.

Kalshi filed a lawsuit against the CFTC making those points, among others. Hearings were held just a week ago.

As Kalshi notes:

The Order’s analysis fails at every step. It contorts and misapplies the CEA’s text, ignores its structure and purpose, allows a narrow exception to swallow the rule, and engages in faulty and unsupported reasoning.

Trading an event contract can never amount to terrorism, assassination, or warfare. Accordingly, the only way to make sense of the provision as a whole is to read the CEA’s reference to contracts that “involve” those activities as focused on the contract’s underlying event. For example, the Commission may prohibit a contract contingent on whether the President will be assassinated.

Their lawsuit was filed against a 2023 decision by the CFTC to reject a Kalshi application to list election contracts — but the logic equally applies to the new CFTC proposal to ban all event contracts.

I’m biased in my sympathy to prediction markets, and not a lawyer. But to my eye, the lawsuit sure seems to make strong arguments.

Kalshi’s co-founder still has hope that the court might rule in its favor before the election, paving the way for them to list election contracts before the election. A ruling is expected between June and September.

If the judge rules in favor of Kalshi, that could force the CFTC to allow not only Kalshi election markets, but it would also jeopardize the logic outlined in the CFTC’s proposed ban, as it is fundamentally the same.

I talked with two people who have been very closely following the case, and they both put the odds of Kalshi winning at about 55% — up from what they had thought before the hearing, as it apparently went well. Play-money markets (which are admittedly very thin, with just 23 traders in total) put the odds a bit lower:

Can the CFTC be swayed? Worth a try, says PredictIt

The courts are the primary hope in blocking the CFTC’s prediction market ban. If that fails, the other possibilities are A) Trump winning the election, or B) the CFTC commissioners changing their minds.

I think the odds of the CFTC commissioners changing their minds are very low, but PredictIt has emailed their traders encouraging everyone to submit public comments with the CFTC. They write:

We need you to act now to save elections markets. The CFTC is accepting public comments on its proposed rule, but only for a limited period. Time is short. Please take this opportunity to tell the commission about your own experience as a seasoned political trader and why you think they are making a mistake.

Read the proposed rule and leave your comment to the CFTC here:

SUBMIT A COMMENT

Believe it or not, the CFTC is required to read and respond substantively to every public comment. Proposed rules are often modified and, in some cases, withdrawn based on information received during the comments period. The more comments, the better!

Anyone can submit a comment. It doesn’t need to be fancy — it can just cite legal arguments like the above, or like the points Kalshi raises in their filing.

There’s one month left to submit public comments.

PredictIt could win a separate legal battle, which would allow it alone to operate

Back in 2014, when the CFTC was more reasonable, it granted PredictIt a “no action” letter, which effectively allowed PredictIt to operate. Then in 2022, the CFTC revoked the “no action” letter and ordered PredictIt to shut down.

Since then, PredictIt has been suing the CFTC in court, and so far, courts have forced the government to let PredictIt stay open while a ruling is pending.

PredictIt recently won a fight over jurisdiction, so that their case will now be held in Texas, in the 5th Circuit — which tends to be friendlier towards markets.

A ruling on that case isn’t expected until next year. If that ruling goes well, then things will continue as they have since 2014, where PredictIt has a grandfathered monopoly on prediction markets. Well, not entirely a monopoly. Specifically:

• The Iowa Electronic Markets is also exempt, as it holds the only other “no action” letter from the government — but you literally need to mail a check to fund an account there, and traders are limited to $500. It’s an academic’s hobby, not a business.

• Manifold Markets has been a play-money market up till now, but in about a month, it will add a bit of a real-money aspect to the site, in which traders will win real-money prizes which are proportional to investment performance. Their strategy leans on an exemption in the law for sweepstakes, which are legal.

But aside from those things, PredictIt would again be the only major, clearly-legal operation — if Kalshi loses its lawsuit against the government, and PredictIt wins its suit. That’s not ideal, but I’d rather be able to trade at PredictIt than nowhere!

Conclusion: I’m optimistic

Being at the Manifold conference this weekend showed me just how actively many smart entrepreneurs are in the space, working to counter the CFTC’s bans in court using many different strategies.

There are at least 3 separate legal approaches being tried simultaneously. To recap:

— Kalshi’s lawsuit, challenging the heart of the CFTC’s authority to ban prediction markets.

— PredictIt’s lawsuit, fighting to preserve its grandfathered status as a legal US exchange.

— Manifold’s attempt to merge sweepstakes with play-money markets.

This gives a lot of potential avenues for at least some prediction markets surviving in the US.

Considering the Kalshi case, let’s say there’s a 50% chance the courts eventually reverse the CFTC, a 40% chance Trump wins and his appointee overturns the ban, and a 5% chance the CFTC just changes its mind.

Then, the odds it will be banned are: (.5 * .6 * 95/100) = 28.7% chance prediction markets in general will be banned. That’s very close to my previous estimate of 30% — but this estimate is more informed by people close to the issue.

And within that, let’s say there’s another 50% chance that PredictIt is allowed to operate.

And also another 50% chance that Manifold becomes a meaningful real-money market using sweepstakes.

That would suggest something like a (.5 * .5 * .287) = 7% chance that prediction markets will be totally banned in the US.

That’s comforting.

In general, attending Manifest this weekend, I got the sense that there is a lot of entrepreneurial energy going into prediction markets.

This weekend, Scott Alexander also asked Nate Silver about the likelihood that, in 20 years, prediction market odds will be as central to political discourse as polls are today. Silver estimated a 20% chance that they would be as central as polls, and also an 80% chance that they would be more-cited than today.

That seems right.