This week, the CFTC released a 267-page notice of proposed rulemaking for prediction markets. Notably, the CFTC’s proposal doesn’t ban any single category of trade, such as contracts for elections or sports.

But while every contract is subject to individual determination, the CFTC indicated that certain transactions are likely to be found contrary to the public interest.

“The CFTC will protect the integrity of our regulated markets without standing in the way of responsible innovation,” CFTC Chairman Michael Selig said. “This proposal gives the Commission a durable, transparent framework to identify the contracts Congress directed us to scrutinize while letting legitimate markets move forward.”

The background

The idea behind prediction markets is relatively simple: Users can buy shares in possible outcomes for various events. Using the example of the presidential race, one share on that market would represent a “yes” for Trump winning, and another a “no.”

The price of a yes is $1 if Trump does indeed win but goes to zero if he loses. If the price starts at 50 cents, that implies that he has a 50% chance of winning. Any user who thought Trump’s odds were better than that could buy a yes contract. If Trump then won, he would have gotten 50 cents for every contract he bought at 50 cents.

Broadly, the CFTC oversees markets where people trade derivatives, or contracts tied to prices, such as for commodities like oil or wheat. But prediction markets with event contracts also fall under the CFTC’s purview.

In 2020, the CFTC issued Kalshi regulatory approval, making it the first fully regulated financial exchange for event contracts. But the other prediction market behemoth, Polymarket, has its main exchange operating internationally.

Some advocates of prediction markets are praising the new prediction market proposal.

“The proposal rightly allows prediction market venues to offer event contracts on the outcomes of most sports events and elections,” John Berlau, a senior fellow and director of finance policy at the libertarian Competitive Enterprise Institute, told the Washington Examiner.

As part of the clarity push, the CFTC outlined which contracts might be limited under the rulemaking: those that can be easily gamed or that it finds aren’t in the public interest.

War and assassinations

Prediction markets such as Kalshi and Polymarket got a lot of attention during the capture of former Venezuelan President Nicolas Maduro earlier this year. In the proposal, the regulator hinted that most wagers on assassinations, wars, and terrorism would not be approved.

For instance, in the proposal, the CFTC notes that an event contract that settles on whether Iran initiates armed conflict in the Strait of Hormuz would involve war or terrorism “because in those event contracts the settlement-determining occurrence is within the Enumerated Activity itself.”

“By contrast, an event contract that settles on whether a specified volume of crude oil transits the Strait of Hormuz during a specified period does not involve war or terrorism, even though the amount of oil flows through the Strait could change based on military conditions, because the settlement determining occurrence is a measurement of commercial shipping activity rather than an occurrence within a war or terrorism activity,” the proposal reads.

Sports gambling

Prediction markets have come under scrutiny by individual states over claims that sports contracts are merely a way to skirt state gambling laws. Under the proposed rulemaking, the CFTC doesn’t push to ban sports contracts, but does outline which are likely to be found contrary to the public interest.

One such sports contract likely to be found in violation and not approved under the proposed guidelines involves player injuries.

“The Commission preliminarily believes that event contracts that explicitly settle solely by reference to the duration, severity, occurrence, or medical diagnosis of an injury sustained by a specific athlete raise serious public interest concerns,” the proposal reads.

The commission said that such contracts would create perverse financial incentives that could encourage harm to athletes.

The CFTC also highlighted sports contracts that are related to officiating outcomes. That is because a small group of people could theoretically throw the odds given, how few referees there are.

“Unlike final score outcome contracts, event contracts based on officiating decisions resolve on the basis of a small number of discrete human decisions made by identifiable individuals under significant pressure and with limited accountability in real time,” the CFTC said.

The CFTC also flagged what it referred to as “discrete-action contracts involving specific participants.” Those are essentially sports contracts that would come down to settling solely on a play or action by a specific player.

An example of this would be “first-pitch” contracts in baseball games, where users could wager on which specific pitch a pitcher might throw at the start of a game. 

The CFTC also said that contracts on physical altercations would raise public interest concerns.

Such event contracts could create a direct financial incentive for both athletes and market participants to encourage, facilitate, or provoke such conduct,” the agency said.

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Additionally, the CFTC signaled that contracts on precollegiate sports events would also likely not be approved under the guidelines. The agency pointed out the weaker governing bodies in precollegiate sports, such as high school football. The proposal also points out concerns about insider trading at that level.

The CFTC prediction markets proposal will now be subject to a 90-day public comment period where interested parties are welcome to weigh in and provide feedback.