Prediction Market Trading The intersection of trading and gambling

Taking a gamble

Occasionally, you might be tempted to buy some stocks or shares that feel a little risky. You might even use the words ‘I’ll take a gamble on that company’, but you don’t mean that you are placing a bet with a bookie; you are just buying stock that might lose value or could have a healthy return and be a major boost to your portfolio and unlock your investment potential.

High-yield bonds offer high returns, but are much riskier. Investments in emerging markets and options, such as futures, are not for everyone and can result in the total loss of your investment. However, you are buying a ‘share’ in the company, and if it succeeds, so do you. But these are most definitely business transactions that require careful consideration and market knowledge.

Entertainment versus business

Pure gambling, whether sports betting or casino gambling, falls into the entertainment sector. You might choose to buy stocks in a gambling company, but that is a very different affair from playing the games or backing a side to win (or lose). However, a new way to back a side is emerging which, while looking like gambling, is legally trading. Welcome to the world of prediction markets, the intersection of trading and gambling!

If you have not heard about prediction markets as a sector, you might still have heard about Kalshi and Polymarket and wondered what they were all about. Because gambling in the US is very restrictive, entrepreneurial thinkers are always looking at ways to exploit any potential loopholes. While the gambling companies lobby state legislators to try and persuade them to legalize what is currently on offer, alternative thinkers come up with something alternative.

US gambling market is scrappy and fragmented

If you look at the online casino market in the US, it is currently only legal in a handful of states. Real money gambling is regulated at a state level, so the US is actually 50 individual, fragmented markets. Sports betting is much more widely accepted, but it is still only accessible online in 30 states. With real-money online gambling being off the agenda in two of the country’s most populous states – Texas and California – unsurprisingly, people have been trying to find a workaround. There have been two quite different approaches: prediction markets and sweepstakes casinos.

Sweepstakes casinos have been ‘sweeping the country’ for several years. According to Casino.org’s gaming specialists, who rate and review real-money online casinos, sweepstakes casinos, and prediction markets, there are now gambling or quasi-gambling options available for almost everyone, everywhere. How long this will be the case remains to be seen, as there are ongoing legal battles in both the prediction market and sweepstakes casino sectors. Prediction markets are the latest ‘new-kids-on-the-block, and they are not turning up quietly.

How are they legal and how do they work?

Prediction markets are federally regulated by the Commodity Futures Trading Commission (CFTC) and are officially structured as derivatives (also known as event contracts). Unlike traditional betting, where you place a bet against a third-party bookie, prediction markets are peer-to-peer platforms where users trade on the outcomes of real-world events. The price is set by the market and the likelihood of something happening (or not happening). In that respect, they are akin to traditional trading.

However, unlike trading stocks and shares, buying into a YES or NO outcome is a time-limited holding. When the outcome of the event is known, the trader is not left with anything to own. You either ‘win’ or ‘lose’. If you win, you get the payout; if you lose, you get nothing. So, if you bought a YES for say $0.6 and you predict the right outcome, you will get a payout of $1 per trade.

While traditional betting platforms and online casinos make their money through ‘house edge’, the prediction market platforms charge fees. They are simply instruments that allow traders/gamblers to back their hunches with real-money trades and are not involved in setting the ‘odds’.

Legal challenges

The legal status of prediction markets is creating considerable tension in the US for a variety of reasons.

In conservative states like Utah, the Governor is more than a little upset that residents now have legal recourse to back a hunch with money. In fact, the state’s lawmakers are united in pushing for a ban – the state’s heavily Mormon population is opposed to all forms of gambling.

Meanwhile, in states where online gambling is an essential source of revenue, lawmakers object because prediction markets bypass their systems. Online gambling platforms are also unhappy.

Back in April, a Nevada judge extended a ban on Kalshi from offering event-based contracts that would allow the state’s residents to place ‘bets’ on sports and other matters without obtaining a gaming license. Kalshi said they do not need one because the contracts are swaps regulated by the CFTC. The judge was unconvinced.

The legal position is likely to run and run, with claims and counterclaims between state and federal authorities. Sixteen states are involved in legal proceedings against prediction markets, and the CFTC has sued six states to defend its claim to exclusive jurisdiction over event contracts. The commission said it would target any state that undermined its authority, but so far, it has only sued those with Democratic attorneys general.

Prediction market apps are growing at a ferocious rate, and notional volume has rocketed since the 2024 presidential election. Monthly volume is comparable to that of high-risk exchange-traded products that use debt and derivatives to multiply returns. However, they are not yet competing against flagship products favored by retail traders, such as zero-day-to-expiration options on the S&P 500 Index.

Hedging the bets

Meanwhile, some of the biggest gambling companies are hedging their bets and launching their own prediction market services. FanDuel and DraftKings have both thrown their hats into the ring and offer event contracts. They do not offer options on sports events in states where they already hold licenses for this. This is most definitely a defensive move to prevent the upstarts from stealing market share. However, it has given them much broader access than before, allowing them to offer services nationwide.

Predict the outcome?

It will be interesting to see what happens as the market matures and the court cases resolve. Many people predict that it will go all the way to the Supreme Court. Ultimately, there will be a winner and a loser. The battle will become an event in its own right that people might want to take a position on!