Before derivatives were regulated, they were chaotic. In the late 1800s, Americans crowded into “bucket shops,” informal parlors where people bet on the prices of wheat, stocks, and railroads without ever touching the real market. Prices were copied off ticker tape. Trades never left the room. It looked like finance, felt like gambling, and eventually became such a mess that lawmakers decided the only solution was a national rulebook. That decision gave us modern derivatives law, federal oversight, and the idea that speculation is made legitimate when it happens on real markets with real rules.

Prediction markets are the first genuinely new test of that system in a century. They are a modern expression of an old idea: the ability to trade or hedge any possible event. Whether it’s forecasting inflation, tracking the progress of AI advancements, or estimating the probability of rain in Miami, prediction markets can translate a belief into a tradable financial position. 

Their recent mainstream adoption has amplified key legal and regulatory questions, just as bucket shops did a century ago: Is this trading or gambling? Who gets to regulate it? What counts as a real market? Who gets to access these markets? These may sound like straightforward questions, but founders need them answered clearly in order to build with confidence.

This paper is about why those questions are back, why the answers aren’t obvious, and why founders building prediction markets today are navigating the most consequential regulatory moment the sector has ever faced.

A new market meets an old law

Event contracts are derivatives that generally fall within the regulatory jurisdiction of the Commodity Futures Trading Commission (CFTC), the primary federal regulator for derivatives markets. The Commodity Exchange Act (CEA), the statutory foundation for derivatives law, defines “commodity” broadly — so broadly that almost any good, service, right, or interest can be the subject of a derivative. Real-world outcomes fit comfortably within that definition. Elections, macroeconomic indicators, weather, and other such outcomes serve as valid underlyings for derivatives contracts. 

As a result, prediction markets offering event contracts to U.S. retail must operate within the federal derivatives framework and be offered on CFTC-regulated venues.

Prediction markets’ … recent mainstream adoption has amplified key legal and regulatory questions, just as bucket shops did a century ago: Is this trading or gambling? Who gets to regulate it? What counts as a real market? Who gets to access these markets?

But it’s unclear how exactly the CFTC expects these products to be structured and how platforms should expect to be regulated. The CEA does not contain a dedicated framework for event-based derivatives, let alone those offered to retail. Instead, the statute is intentionally broad and principles-based, largely due to financial innovation rapidly outpacing progress on specific legal frameworks. The CEA uses flexible definitions or frameworks for swaps, futures contracts, options, and other derivative categories that turn on based on how each product functions in practice. 

Effectively, derivatives platforms are tasked with justifying — through a short economic and legal analysis — which category they think their product lives in and then illustrating how they intend to comply with the statutory and regulatory requirements applicable to that category. 

Ambiguity as runway and constraint

While the principles-based norms of derivatives law offers flexibility, they also create uncertainty that shapes how prediction markets evolve in practice. These norms initially enabled experimentation, but now they are constraining these markets’ scale.

On one hand, the absence of rigid definitions allowed early prediction markets just enough regulatory runway to experiment, iterate, and find product–market fit in the United States. While event contracts are not entirely new, previous iterations existed at much smaller scales and nothing like today’s retail-facing markets. Within this ambiguity, the industry chose a conservative approach to compliance to reach retail users. Under this approach, contracts are structured as swaps, centrally cleared through a derivatives clearing organization (DCO) and listed on a designated contract market (DCM), satisfying familiar requirements around market integrity and risk management. 

This DCM + DCO architecture enabled prediction markets to emerge on CFTC-regulated venues: platforms have been able to justify derivatives classifications for their products, apply for the necessary licenses, and earn some clarity on the downstream requirements they’ll have to comply with.

On the other hand, that same flexibility also creates a constraint. Because derivatives law leaves key questions unresolved, prediction markets face uncertainty as they try to scale, especially when modern event contracts borrow elements from multiple derivatives categories. Some use cash-settled, binary payoffs that resemble simple swap structures. Others trade with continuous orderbooks and margining similar to exchange-listed futures. Many retain conditional elements reminiscent of options. The CEA can accommodate these features in isolation, but without guidance on how the law should apply when features are combined, founders are left operating in a regulatory gray area.

The CFTC has not issued comprehensive guidance affirming how event contracts should be treated across contexts, nor has it defined clear, durable boundaries for what constitutes a compliant event-based derivative. That posture is, in part, consistent with the CEA’s intentionally flexible approach and with how the CFTC has historically addressed novel derivatives products (historically through a mix of interpretive statements, enforcement actions, and exchange-level certifications, rather than bright-line rules). At the same time, the scale and accessibility of modern prediction markets introduce questions that earlier precedents did not fully confront. 

The absence of rigid definitions allowed early prediction markets just enough regulatory runway to experiment, iterate, and find product–market fit in the United States…On the other hand, that same flexibility also creates a constraint. Because derivatives law leaves key questions unresolved, prediction markets face uncertainty as they try to scale, especially when modern event contracts borrow elements from multiple derivatives categories.

Clear articulation from the CFTC about how it categorizes event contracts (and what it expects from platforms listing them) would meaningfully reduce uncertainty for builders and help insulate good-faith projects from abrupt policy reversals under future administrations. The DCM + DCO model has enabled prediction markets to operate, but it rests heavily on inference.

As a result, many founders are operating with material interpretive risk: some have chosen to confront that uncertainty directly by building within existing regulatory pathways, while others remain cautious as they seek clearer signals about how the agency will apply legacy principles to this new class of products.

Where uncertainty becomes intervention risk

Even where event contracts are reasonably interpreted and designed within existing legal frameworks, they still face a separate and more consequential risk: discretionary intervention by the CFTC after a market is live. The agency can use its discretion to intervene at multiple points in a market’s lifecycle, regardless of the platform’s attempt to comply.

One such point concerns the broad authority of the CFTC to prohibit entire categories of event contracts if it determines they are “contrary to the public interest,” particularly contracts involving war, terrorism, assassination, political activity, or gaming. Historically, this authority was rarely invoked, but it resurfaced in 2023, when the CFTC under the Biden administration implicitly relied on these public-interest concepts to block Kalshi’s election markets. The agency ultimately withdrew that posture following legal challenge, and current CFTC staff has since clarified that it recognizes this authority but has not exercised it. 

Regardless, the absence of a transparent standard for when the CFTC could deem a market contrary to public interest leaves platforms exposed to uncomfortable amounts of risk. Entire verticals could be deemed impermissible based not on structure or safeguards, but on subject matter alone, making it difficult for builders to assess the long-term viability of new markets.

Resolution parameters present another source of tension between prediction markets and derivatives law. In traditional derivatives markets, settlement is typically objective, mechanical, and final. Prices or outcomes are determined by referencing clearly specified benchmarks or methodologies, with minimal discretion and predictable timing. Event contracts, by contrast, must resolve whether a real-world outcome “occurred,” which can require interpreting external facts, reconciling conflicting data sources, or accounting for post-event developments. While the CEA can accommodate non-price-based settlement in principle, it offers little guidance on how outcome-based resolution mechanisms should be evaluated in practice. As a result, prediction markets have experimented with approaches to resolving contested outcomes, including predefined dispute processes or governance-based mechanisms. Although these designs may be sensible from a product perspective, they do not map cleanly onto regulatory assumptions around objectivity, finality, and resistance to manipulation, leaving founders uncertain about how regulators will assess resolution choices.

Susceptibility to manipulation presents a further point of regulatory tension, and one that takes on heightened significance in outcome-based markets. Under the CEA, derivatives contracts must not be readily susceptible to manipulation. This is a core principle of derivatives regulation that gives the CFTC broad discretion to intervene based on how a market is designed and operates, not just whether misconduct has occurred. For prediction markets, this concern extends beyond price manipulation to the possibility of influencing the underlying event outcome, the information used to determine it, or the timing and interpretation of its resolution. These risks do not make prediction markets inherently non-compliant, but they do mean that manipulation analyses cannot simply be imported from legacy markets. Without clearer guidance on how the CFTC will evaluate susceptibility to manipulation in outcome-based contracts, founders are once again left to assess these risks through inference rather than instruction.

Taken together, these unresolved tensions illustrate why ambiguity that once enabled experimentation now constrains scale. While the current compliance model has shown that prediction markets can operate within the federal derivatives framework, it leaves builders exposed to retroactive intervention from interpretations of legacy rules. As prediction markets grow in significance, clarity around how the CFTC will exercise its discretionary authorities becomes essential. Otherwise, good-faith projects can be unwound due to poorly articulated standards.

Legal and regulatory battlegrounds

The legal uncertainty surrounding prediction markets is no longer abstract. Questions about how they fit within existing law are being tested in real time by regulators deciding when to intervene, by courts resolving jurisdictional disputes, and by policymakers weighing whether statutory change is necessary.

The answers will not emerge all at once or from a single source. Instead, they are likely to take shape through a small number of live legal and regulatory battles:

1. Clarifying the law: How the CFTC interprets and restricts event contracts
2. Federal preemption, sports gambling, and the tribes: Whether states and tribes can regulate sports-based (or other) markets
3. DeFi derivatives: Whether decentralized prediction markets can fit within existing derivatives law.

Level 1: Clarifying the law

The first battle is one that is long overdue: how the CFTC exercises its authority with respect to event contracts under existing derivatives law and when it decides to prohibit them outright. 

Under the prior administration, the agency did little to resolve the growing tensions between prediction markets and existing derivatives law. Rather than explaining how classification questions should be approached or clarifying how platforms should expect intervention to be applied, the Biden-era CFTC chose to maintain the status quo of ambiguity. Skepticism toward crypto did not just delay guidance; it compounded uncertainty by leaving builders to infer compliance standards while facing heightened risk that markets could later be unwound.

While the current compliance model has shown that prediction markets can operate within the federal derivatives framework, it leaves builders exposed to retroactive intervention from interpretations of legacy rules.

Today, however, there is a meaningful opportunity for clarity. The current administration has articulated a pro-innovation stance on digital assets and onchain finance, and current CFTC Chair Mike Selig has signaled a commitment to modernizing the agency’s thinking. In announcing the CFTC’s “Future-Proof” initiative, Chair Selig emphasized replacing regulation-by-enforcement with clear, fit-for-purpose rules developed through rulemaking. He explicitly cited prediction markets as an area where tailored regulatory frameworks are needed.

With the CFTC’s leadership now explicitly focused on modernizing derivatives regulation for emerging markets, the agency is positioned to deliver durable, common-sense guidance that unlocks further growth in prediction markets.

Guidance, whether in the form of interpretive letters, advisories, or rulemaking, could begin to explain how the CFTC views event contracts, what obligations platforms must satisfy, and where the agency draws the line between permissible and prohibited markets. This is the battleground where clarity is most attainable, and where thoughtful engagement between regulators and industry can reduce uncertainty.

Level 2: Federal preemption, sports gambling, and the tribes

The second battleground concerns whether states and tribes, rather than the CFTC, can regulate sports-based event contracts listed on federally regulated derivatives exchanges. At its core, this is a dispute about federal preemption: When a product falls within the CFTC’s jurisdiction and complies with federal derivatives law, can states or tribes impose their own gambling rules?

U.S. derivatives regulation has long been built around a national market structure. Once a contract is lawfully listed on a CFTC-regulated exchange, it is intended to trade nationwide under a single federal rulebook. That principle exists because derivatives markets depend on national liquidity and uniform regulation; allowing states to block or condition federally permitted products would fragment markets and undermine price discovery. For decades, regulators interpreted the CEA to avoid overlap between federally regulated derivatives and state-regulated gambling.

That separation became far more fragile after the Supreme Court’s 2018 repeal of PASPA, which lifted the federal ban on sports betting and triggered a rapid expansion of state-regulated sportsbooks. In the years that followed, state gambling regulators revived an old instinct: If a product looks economically like a wager, it should be treated as gambling. Sports-based prediction markets brought that instinct into direct conflict with federal derivatives regulation.

When Kalshi listed sports-based contracts on its CFTC-regulated exchange, multiple state gambling commissions — including those in New Jersey, Nevada, and Maryland — responded with cease-and-desist orders. These regulators argued that if a contract’s payout depends on the outcome of a sporting event, the platform offering it is engaged in state-regulated wagering, regardless of federal oversight. Kalshi has challenged those orders in court, arguing that its products are derivatives contracts, not wagers, and that states lack authority to regulate federally permitted markets.

States have attempted to bolster that position by arguing that the CEA reflects congressional intent to exclude sports- or gaming-based event contracts from the federal derivatives regime. Under this theory, sports-based prediction markets are impermissible not because of how they are structured, but because of what they reference. That reading stretches a discretionary review authority into a categorical prohibition and remains contested. If the CFTC were to clearly state that it does not interpret its authority as excluding sports-based event contracts, those state arguments would weaken substantially; in the absence of such clarity, states will continue to press the issue in court.

At the same time, tribal governments and industry groups are pursuing a parallel strategy through Congress. Tribal advocates argue that sports-based prediction markets threaten the economic foundation of tribal gaming, which operates under federally protected exclusivity arrangements. They have urged lawmakers to amend the CEA to explicitly prohibit CFTC-regulated entities from offering sports- or casino-based contracts. While legislative change is unlikely to move faster than court rulings or agency guidance, the tribal push raises the stakes by introducing the possibility that Congress — not just courts or regulators — could foreclose entire categories of prediction markets.

The outcome of court battles will determine whether sports can become a viable U.S. prediction-market vertical at all. If courts uphold federal preemption, sports markets could continue to scale nationally. If state claims prevail, prediction markets may face a patchwork of overlapping gambling regimes that effectively shut sports prediction markets out of the United States.

Level 3: DeFi derivatives

The third battle will determine whether onchain prediction markets can serve U.S. users at all, or whether innovation will be forced into centralized iterations. 

This question extends beyond prediction markets themselves and goes to the broader future of onchain derivatives. Even as centralized platforms grapple with classification and listing uncertainty, decentralized systems raise a more fundamental challenge: whether U.S. derivatives law can accommodate markets that are not built around traditional intermediaries.

The first dimension of that challenge is structural. The CEA assumes the presence of identifiable entities that can register, be supervised, and be held accountable — exchanges, clearinghouses, and other intermediaries with clearly defined roles. Decentralized systems challenge this assumption by distributing those same functions across a network of validators, where no single actor controls the system end-to-end. This design complicates basic regulatory questions: who is the exchange, who bears compliance responsibility, and who is accountable if something goes wrong?

Even if those structural questions were resolved, a second and separate constraint remains: retail access. U.S. derivatives law has long limited when and how retail users can trade derivatives outside of regulated exchanges. Those restrictions apply to the act of trading itself, not just to the platforms that facilitate it. As a result, unlocking onchain prediction markets is not simply a matter of exempting developers, validators, or frontends from incompatible registrations. It also requires defining the conditions under which U.S. users may lawfully trade derivatives on decentralized infrastructure. 

Taken together, these dual tensions make onchain derivatives the most difficult battleground to resolve. Enabling decentralized prediction markets would require paired clarity: guidance on how decentralized market infrastructure fits within derivatives regulation, and guidance on when retail participation in such markets is permitted. The current administration has expressed an interest in modernizing derivatives regulation and supporting onchain innovation, but translating that ambition into workable rules is complex and politically contested. 

U.S. derivatives law has long limited when and how retail users can trade derivatives outside of regulated exchanges.

Recent CFTC actions suggest that this kind of clarity is not without precedent. Late last year, the CFTC withdrew its 2020 “Actual Delivery” guidance. That guidance had been used to support enforcement actions that treated software developers and frontend providers as if they were offering off-exchange retail commodity trades — simply because they provided user interfaces to decentralized protocols. By reversing that position, the CFTC signaled a more nuanced understanding of how user interfaces and decentralized infrastructure fit into existing derivatives law — an approach we hope informs how the agency addresses onchain derivatives regulation going forward.

For builders, the takeaway is clear: the future of decentralized prediction markets in the United States hinges not on technology alone, but on whether regulators can reconcile legacy derivatives rules with new market structures and new modes of participation.

Ambiguity is not a neutral state 

The path forward for prediction market regulation is not mysterious. The most favorable outcome is the emergence of a coherent and durable framework that explains how event contracts fit within derivatives law, affirms federal preemption for lawfully listed markets, and creates space for both centralized and decentralized models to develop under clear expectations. Clarity across these fronts would unlock the full lawful potential of prediction markets — supporting new verticals, national liquidity, and responsible innovation — while preserving the core market-integrity principles of the CEA.

The risks of falling short are equally clear. If guidance does not materialize, if courts reject federal preemption, or if decentralized participation remains legally unresolved, builders will continue to face a future defined by fragmentation and retroactive uncertainty. Some categories of contracts could remain off-limits absent congressional action, and the CFTC will retain discretion to prohibit markets based on subject matter.

But ambiguity is not a neutral state. Long-term success will depend not on racing ahead of the law within ambiguous frameworks, but on engaging with regulators to shape a durable future where prediction markets scale lawfully and in line with the spirit of U.S. financial regulation.

Special thanks to Jake Chervinsky, Daniel Barabander, and Brad Bourque for the thoughtful feedback on this paper.