Prediction markets thrive in the legal gray areas of gambling

Prediction markets are the latest in a long line of examples of how gambling innovation is taking root in the gray areas.

Major prediction markets are embroiled in lawsuits across the country, with some states like Arizona banning some operators altogether. State governments claim that the services circumvent necessary gambling licensing laws, while the prediction markets argue that they should not be subject to state-level regulation.

While there are some ways in which prediction markets are mimicking traditional gambling, especially sportsbooks, there are also clearly ways in which they are innovating. Traditional gambling companies wouldn’t offer as much entertainment or political betting – if at all. Local betting shops don’t offer odds on what a tech CEO is going to say at the next meeting.

These types of out-of-the-box bets attract a new audience that wouldn’t normally gamble. Speak with SigmaCEO and founder of Yield Sec Ismail Vali noted that people under 30 are the most responsive to prediction markets and their current event contracts.

“Under 30s don’t think they’re gambling,” he said. “They really believe they’re predicting. Whatever that means, but it’s not gambling if it absolutely is.”

Gambling innovation has a long history of operating in legal gray areas

Part of the reason why prediction markets have risen in popularity so quickly, and why they are now receiving so much backlash, is because they operate in the legal gray area.

There is virtually no specific regulation on which prediction markets can offer event contracts, as they are currently regulated by the Commodity Futures Trading Commission (CFTC), which treats them as derivatives exchanges. Some industry leaders like Kalshi are proactively working with the CFTC to maintain this relationship, rather than resorting to state-by-state regulation as with traditional gambling.

Prediction markets may be the current example of gambling innovation emerging just beyond the line of official regulation, but past examples include sweepstakes, slot machines, daily fantasy sports games, and a wealth of other once-innovative, now normalized (and regulated) gambling methods.

“Most U.S. gambling laws are written to regulate clearly defined activities: casinos, sports betting, lotteries, or regulated derivatives markets,” said Braden Perry, a litigation, regulatory and government investigations attorney at Kennyhertz Perry, LLCexplained to ReadWrite. “Innovation happens when a new product doesn’t fit neatly into one of these boxes.

“Prediction markets are a perfect example. They borrow mechanics from futures and options markets, behavioral incentives from gambling, and voice-based framing that resembles polls or predictions. That hybridity creates regulatory ambiguity, and that’s where innovation thrives.”

As Perry further notes, this is far from incidental. The developers of prediction markets seemingly bypass regulations to create something new and avoid being burdened by regulations.

“Developers tend to design products right at the edge of existing definitions: they avoid ‘chance’ by emphasizing skill or information, avoid ‘bet’ by using contracts or tokens, or avoid ‘consideration’ through alternative purchasing mechanisms,” he stated. “This is not accidental. It is a direct response to highly prescriptive gambling statutes that leave little room for licensing experimentation.”

Where should regulations intervene?

Prediction markets are currently in a lightning-in-a-bottle phase. Because there are few specific regulations beyond what applies to derivatives exchanges, the playing field is fairly open for experimentation. That’s a good thing for consumers because it offers a lot of variety, but it also exposes both users and third parties to potential risks.

“Regulators are often reactive rather than proactive in this area,” Perry continued. “Institutions typically wait for scale, damage, or public visibility before intervening, especially when jurisdiction is unclear, such as between gaming regulators, securities regulators, and commodity regulators. That delay essentially becomes a window for experimentation.”

A recent example revolves around Coinbase CEO Brian Armstrong, who poked fun at the prediction markets in the company’s October 30 quarterly earnings call.

lol this was fun – it happened spontaneously when someone from our team dropped a link in the chat https://t.co/tQiV3B9jUj

— Brian Armstrong (@brian_armstrong) October 31, 2025

“I was a little distracted because I was following the prediction market on what Coinbase will say on their next earnings call,” Armstrong said in his parting remarks. as reported by Bloomberg. “I just want to add the words Bitcoin, Ethereum, blockchain, staking and Web3 here to make sure we get these in before the end of the call.”

While obviously just a flippant comment, his comment shows how easily he could manipulate such event contracts. If Armstrong spent money saying that string of words, he could easily fulfill that event contract. Make the words even more random, increase the odds, and he might get even more out of it.

There is currently no real regulatory framework in place to stop someone from doing this, highlighting how such rules are not only prohibitive, but protective for everyone involved. Eventually, organizations will have to catch up, whether at the state or federal level.

“Historically, this is the beginning of many now-regulated products: daily fantasy sports, online poker, esports gambling and even early financial derivatives,” Perry said. “Gray areas are not a bug in gambling regulation; they are a structural feature of the way innovation tests outdated legal frameworks.”

Featured image: Midjourney