U.S. Political Prediction Markets :Why Kalshi’s Court Victory Matters

Aaron Brogan serves as the chief legal officer at Brogan Law PLLC, focusing on areas like cryptocurrency regulations and disagreements. Meanwhile, Matthew Homer functions as a venture capital investor and consultant for entrepreneurs operating within the cryptocurrency sector.

Under the leadership of Rostin Behnam, the Commodity Futures Trading Commission (CFTC) has adopted a firm stance towards forecasting markets. Initially, in January 2022, the Commission imposed a $1.4 million fine on the crypto-based prediction market Polymarket and instructed them to halt operations within the U.S. Subsequently, in August 2022, the CFTC revoked the no-action letter for the traditional fiat-based prediction market PredictIt, a move that could potentially shut down this platform as well.

In simpler terms, Kalshi had a layer of protection as it was legally registered as a regulated marketplace, more specifically, a Designated Contract Market (DCM). This status grants Kalshi the ability to independently approve contracts related to events, often referred to as “event contracts.” However, the Commodity Futures Trading Commission (CFTC) can restrict these contracts only if they contradict public interest or involve certain activities such as war, terrorism, and gambling.

In September 2023, Kalshi tried to validate a market predicting who would hold power in each house of Congress. However, the Commodity Futures Trading Commission (CFTC) promptly issued a ruling rejecting the contract and thus barred Kalshi from listing event contracts related to political results.

In simpler terms, the CFTC contends that Kalshi’s political contracts qualify as gambling since they require placing a wager on the results of congressional elections. These contracts, known as Congressional Control Contracts, are based on the outcomes of these specific electoral competitions.

In a recent court decision this week, Judge Cobb, appointed by President Biden, expressed a differing viewpoint. He ruled that Kalshi’s contractual agreements concerning congressional control do not involve illegal activities or gambling, but instead encompass political matters such as elections, control of Congress, and related topics.

At a September 12th hearing, the CFTC contended persistently that the case should be put on hold (a pause in proceedings) while an appeal is ongoing, with the effect being that the contracts would remain inactive.

Even though Kalshi emerged victorious in the case, the Commodity Futures Trading Commission (CFTC) requested a temporary halt to proceedings because listing any of their contracts could result in irreversible damage. On Thursday, the D.C. Circuit Court of Appeals granted this stay to the CFTC.

The reason the agency is concerned about these contracts being publicly accessible, however briefly, is because they’re currently involved in what’s called “after-hours regulation” or “midnight rulemaking.

It appears that, possibly noticing the flaws in its arguments, the Commodity Futures Trading Commission (CFTC) started taking precautions in May. To do this, they proposed a rulemaking to clarify what constitutes “gaming” under their authority. In the announcement, the Commission aimed to expand the definition of gaming by proposing a broader interpretation.

Betting, which refers to placing value at stake based on:

Independent entities such as the Commodity Futures Trading Commission (CFTC) function without taking direct orders from the President. Yet, the President has the authority to nominate most of the five commissioners from their respective political parties. It’s common for the Chairperson to step down when a new president enters office, as Heath P. Tarbert did in 2021. Consequently, with Biden no longer running in the election by July 21, the Benham Commission effectively lost its influence and power.

We know a Republican CFTC would take a less hostile stance to prediction markets than the current Commission because the current Republican Commissioners have told us so. Commissioners Summer Mersinger and Caroline Pham dissented to the Kalshi order and to the proposed rulemaking, with Commissioner Mersinger arguing “it is hard not to conclude [ ] that [the proposed rule] is motivated more by a seemingly visceral antipathy to event contracts than by reasoned analysis.” Similarly, Kamala Harris, should she win, will have an opportunity to set her own direction at the Commission.

The existing CFTC is aware of this fact. If it were to acknowledge that Kalshi’s contracts are legal under the current regulations and delay its rulemaking, then a future administration could potentially take a different approach. However, instead, the CFTC appears to be taking aggressive measures to prevent these contracts from being offered in the market while it still holds power.

Critics argue that actions taken late in an administration’s term, often referred to as “midnight regulations,” are problematic due to the reduced political accountability of an outgoing administration compared to one that might be seeking re-election.

While it appears that the CFTC’s attempts might be futile, there is a glimmer of hope. According to Judge Cobb’s decision, the proposed rule could potentially allow for the continuation of event contracts related to elections altogether.

According to Judge Cobb’s interpretation, a contract or deal only pertains to a specified action if the event being exchanged within that contract is connected to that specific activity. The Kalshi contracts were not considered gambling. The proposed rule modification adjusts the definition of gaming to mean “betting or risking something of worth on the outcome of a competition,” but it does not alter the key language used by Judge Cobb, which refers to involvement. Since elections are not forms of betting, but rather the competitions themselves, under Judge Cobb’s ruling, they would likely still fall outside the jurisdiction of the Commodity Futures Trading Commission (CFTC).

The situation remains uncertain as we wait for the appeals process to conclude, but there’s a possibility that some clarity could emerge even from the late-night rulemaking process. If Judge Cobb’s ruling overrules the Commodity Futures Trading Commission’s proposed rules, it would mean that election event contracts might now be entirely legal.

We hope this marks a turning point in the regulation of these markets. In the past few years, there has been a concerning trend of some federal regulators opting to ban markets they disfavor, rather than fulfill their duty to regulate them. American consumers should be able to engage with well-regulated U.S. entities, even with novel products. It seems some regulators would prefer to push these offshore. In our view, this is not in the public’s interest.

As a passionate cryptocurrency investor, I’d like to share my personal insights that may not align perfectly with the official stance of CoinDesk, Inc. or its associates. These views are shaped by my experiences in this dynamic digital asset market.