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Prediction markets sounds simple. You pick yes or no on a real world event. So that could be whether a team wins or whether inflation hits a certain level, or if a company reaches a key business target. And if you're right, you get paid. These are known as event contracts. But what's not simple is who should regulate these new markets at the federal level. What we're seeing is a new asset class, or at least a very quickly growing asset class that has a number of jurisdictional questions.
This is really a jump ball. Like nobody knows how it's going to turn out. For years, the Commodity Futures Trading Commission or the CFTC has taken the lead because it regulates swaps and derivatives. Those are products built around future outcomes. But as these swaps become more tied to publicly traded companies, the SEC may have a bigger role to play. Most people have been treating prediction markets as purely a CFTC story, and I think that's the right starting point. But Dodd-Frank really carved out a very specific category of derivative for the SEC. And that's the security-based swap.
And security-based swap is essentially any contract whose value is tied to a single company's stock, a loan, or an event that directly affects that company's financial statements or financial condition. That last piece is really the SEC's jurisdictional hook into the prediction markets. Right now, both of the agencies are asking for public comment on where the lines should be drawn. It's part of a push to figure out if current definitions and frameworks appropriately reflect the modern market. So the regulators themselves are still working through who is responsible for what and for platforms like Kalshi, Polymarket and others.
That uncertainty could shape what contracts they can list, which rules they have to follow, and how far prediction markets can go. The CFTC has been the main regulator of event contracts, because many of them are products that pay out based on a future event and are based on financial agreements between two parties. The broad definition of swap in the Commodities Exchange Act, allowed for these sort of one off, you know, yes or no questions to fall pretty squarely within the CFTC jurisdiction. So that's why we started from that place.
A contract on whether the price of oil rises, if inflation hits a certain threshold, or whether a sports team wins a game, may all be different subject matter. But legally the structure can look similar. A future event, a defined outcome, and a payout. Things can get a little more complicated when a publicly traded company is involved. That's thanks to the 2010 Dodd-Frank law. Derivatives are an asset class that the CFTC typically regulates, but when a derivative is tied to a security that falls under the SEC's portfolio, Those are called security-based swaps. If the event is "directly affecting the company's
financial statements," then the SEC has jurisdiction that is 100% a securities concept and not a commodities one. The problem is that what "directly affects" means has really been an open question since 2012. An example of that could be will Apple go bankrupt? That one's pretty obvious, clearly tied to the up and down of the financial health of a publicly traded company. But then you get different iterations of that, such as Will Apple announce a new phone this year, or if the CEO will step down? There's so many different types of questions that can fall under the event contract space.
The area gets much more gray because we're trying to say, well, is that actually something that's underlying question about the price of Apple stock or maybe its it's financial condition, or is this sort of just a one off? Well, that's just a question that looks much more like an event contract swap. That's yes or no. Nothing to do. Maybe with the actual health of Apple stock inherently. But of course those things are related. And I think that's why this starts to get much more murky. At some point, the events contract is becoming a proxy for trading in the performance of a company. And that starts sounding like derivatives of a security.
The CFTC is currently in a rule making process regarding prediction markets, and is soliciting public comment about its first draft. That proposed rule discusses contracts that may be contrary to the public interest, as well as addresses terms like "gaming." It also goes into how the agency would decide whether certain contracts can trade. At the same time, the SEC and the CFTC are jointly asking for comment on definitions of specific derivatives. That includes security-based swaps like we talked about, but also mixed swaps, novel products, and jurisdictional questions. While the CFTC and SEC are asking for public input, that hasn't stopped the CFTC from pushing forward in its
role as the sole regulator of event contracts, for now. Although the CFTC does acknowledge that there is a legal dispute with the states where predictive markets fall in the federal versus state regulatory regime. But the CFTC has at the same time kind of laid down its marker that it does plan to regulate and enforce in this space. The agencies are trying to avoid a regulatory pileup. In March, they announced a memorandum of understanding, and, as they put it, "to guide coordination and collaboration between the two agencies to support lawful innovation." By coordinating more closely, the goal is to reduce redundant requirements and make it clear which agency oversees what.
My colleague Ananya and I reached out for comment. The SEC declined and the CFTC did not get back to us in time for publication. A Polymarket spokesperson told us it is engaging with both the CFTC and SEC on definitional frameworks for prediction market products. It added that the company hopes to avoid duplicative or conflicting compliance requirements, and is encouraged by the harmonization efforts by the two federal agencies.
Kalshi declined to comment to CNBC for this story. The way the rules are written at the CFTC and the way the rules are written at the SEC are fundamentally different approaches. And so if you have to comply with both of them, it often means doing two different things to satisfy two different bosses. And I guess then the real danger is that those products go overseas. And so American investors either can't get to them or worse, they get to them without any protections. And that's when we see more fraud and we see American retail investors hurt. The key context is that these platforms scaled into the relevancy that they have today under only one regulator, the CFTC. And if it's not clear where certain contracts are
regulated, that can potentially add bureaucracy as these platforms continue to scale. So that makes finding out these definitions and making them clear really important for the SEC and CFTC. It seems to me what is urgent is communication and data gathering, because you can't provide standards to what you don't know. I don't think the regulators can afford to have a delay in learning what exactly is going on with a particular market. I think there is a real push to get our arms around this before the genie is way too out of the bottle.
So I can imagine this hopefully will move fast.
