Chapter 38 Key Takeaways: The Regulatory Landscape

Core Concepts

Prediction markets sit at a regulatory intersection involving commodity law, securities regulation, gambling statutes, tax codes, anti-money-laundering rules, and crypto-asset regulation. No single regulatory framework captures all aspects of prediction market activity.
The CFTC is the primary US federal regulator of prediction markets. Its authority derives from the Commodity Exchange Act, which defines "commodity" broadly enough to encompass event contracts.
The Dodd-Frank Act (Section 745) gave the CFTC explicit authority over event contracts while also empowering it to restrict contracts deemed contrary to the public interest — including those involving terrorism, assassination, war, and gaming.

Designated Contract Market (DCM) registration is required to legally offer event contracts to US persons. DCM requirements include self-regulatory capability, financial resources, system safeguards, compliance programs, and market surveillance.
Kalshi became the first event-contract-focused DCM in 2020. Its landmark court victory over the CFTC in 2024 established that political event contracts are permissible under federal law.
No-action letters are inherently precarious. PredictIt's experience demonstrates that building a platform on no-action relief is risky — relief can be withdrawn with limited process and no formal appeal.
The CFTC has brought enforcement actions against Intrade (2012), Polymarket (2022), and various DeFi protocols for offering event contracts to US persons without registration.

The Howey test determines whether a prediction market product is a security. Most traditional prediction market contracts likely fail the "efforts of others" prong, but tokenized outcome shares and governance tokens may qualify as securities.
State gambling laws present a patchwork of risk. The skill-vs-chance debate remains unresolved, with different states applying different legal tests (predominant purpose, any chance, material element).
Federal preemption under the CEA may protect CFTC-registered platforms from state gambling laws, but this has not been definitively tested in court.

MiCA (Markets in Crypto-Assets Regulation) is the EU's comprehensive crypto-asset framework. It requires CASP licensing, white papers for outcome tokens, and stablecoin compliance.
The UK FCA has banned crypto-derivatives (including binary options) for retail consumers, creating a challenging environment for UK-focused prediction markets.
The global regulatory patchwork varies dramatically across jurisdictions — from restrictive (Australia's binary options ban) to moderate (Singapore's sandbox approach) to permissive (certain offshore jurisdictions).

Technology does not determine regulatory status. Using blockchain infrastructure does not exempt a platform from the CEA or other financial regulations.
Regulators target multiple pressure points against decentralized platforms: identifiable developers, front-end interfaces, DNS providers, fiat on-ramps, and stablecoin issuers.
The Tornado Cash sanctions precedent demonstrates that governments can sanction smart contract addresses, with significant implications for decentralized prediction markets.

KYC/AML compliance is mandatory for centralized platforms serving US users. Requirements include customer identification programs, transaction monitoring, SAR filing, and sanctions screening.
Geofencing (IP blocking, VPN detection, identity verification) is the primary mechanism for restricting access from prohibited jurisdictions.
Record-keeping requirements mandate retention of customer identification, transaction records, and compliance documentation for a minimum of five years.

Tax classification matters enormously. Section 1256 treatment (60/40 long-term/short-term split) is significantly more favorable than gambling income treatment (losses deductible only against winnings).
Mark-to-market taxation for Section 1256 contracts means unrealized gains may be taxable at year-end.
Crypto-based prediction markets introduce additional tax complexity through multiple taxable conversion events and cost basis tracking challenges.

The trend is toward greater regulatory acceptance of prediction markets, driven by demonstrated social value, academic support, institutional interest, and bipartisan political support.
Potential federal legislation could clarify the legal framework, establish explicit preemption of state gambling laws, and create tailored registration pathways.
Regulatory sandboxes (like Singapore's MAS sandbox and the UK's FCA sandbox) could accelerate innovation by allowing controlled experimentation under regulatory supervision.

The regulatory strategy decision (register as a DCM, operate offshore, or decentralize) is one of the most consequential choices a prediction market platform makes.
Compliance is a competitive moat. Platforms that navigate the regulatory maze gain legal certainty, institutional trust, banking relationships, and barriers to entry.
Regulatory risk can be modeled as a function of user distribution, enforcement probability, and expected penalties across jurisdictions:

$$R = \sum_{j \in J} w_j \cdot P(\text{enforcement}_j) \times L(\text{penalty}_j)$$