How to Legalize Prediction Markets
What you (yes, you) can do to move humanity forward
In the United States, prediction markets are, with a few minor exceptions, against the law. If you don’t have a legal background, you might think that means that Congress at some point considered the issue, decided people shouldn’t be able to bet on real world events, and passed a law to that effect, which was then signed by the president. But this is not what happened.
As with most things, Congress has never directly considered the matter. Rather, prediction markets are illegal due to the discretion of a government agency called the Commodity Futures Trading Commission (CFTC). Why does it have this right? And on what basis has it made prediction markets illegal?
Among economists, rationalists, and others interested in this issue, there has been a great amount of discussion about the potential benefits of prediction markets and effort towards convincing others of their potential. Yet there is strikingly little in the way of thinking about the practical roadblocks to creating them, and how they can be overcome. I think this is probably because there isn’t much overlap between the kinds of people who know the law, which attracts more practical or overly political types, and rationalists, who are more interested in first-principles reasoning about issues of epistemology, morality, and ethics.
This essay seeks to fill that void. I’m not going to bother explaining to you why prediction markets are great, as that’s already been done (see here, here, and my interview with Robin Hanson). Rather, this essay focuses on what is actually standing in the way of supporters of prediction markets being allowed to start and trade on exchanges. In the process, the reader will learn that scientific progress is being hindered by the decisions of a few individuals who are free to act differently. Knowing this, one can start to take practical steps towards changing the state of the law. The options are pressuring the CFTC to allow prediction markets, passing a law that takes the issue out of its hands, and a judicial ruling forcing liberalization. At the end of this essay, I explain what individuals in different walks of life can do.
When people discuss issues online, there’s always the danger of the conversation itself becoming the point, with participation in the discourse being a source of pride, enjoyment, and status for members of some community. Yet a robust intellectual community is no guarantee of real world success. History provides countless examples of winning political movements that are based on the flimsiest of intellectual justifications, and collections of geniuses who agree on the importance of some political cause that never goes anywhere. The cause of prediction markets will hopefully not remain in that trap.
In 1936, Congress passed and FDR signed the Commodity Exchange Act. In 1974, Congress created the CFTC to enforce the original law, which has been amended on multiple occasions over the years. The CFTC has authority to regulate what are called “derivatives markets.” A derivatives contract derives its value from some kind of underlying asset or benchmark in the real world.
The thing to understand about derivatives is that the baseline is that they’re legal. That’s why you can “bet” on the price of oil through a futures contract. The CFTC wasn’t created to ban derivative markets, but to regulate them, though this can involve prohibiting certain kinds of markets altogether. Current law includes the following provision on event contracts.
the Commission may determine that such agreements, contracts, or transactions are contrary to the public interest if the agreements, contracts, or transactions involve—
(I) activity that is unlawful under any Federal or State law;
(V) gaming; or
(VI) other similar activity determined by the Commission, by rule or regulation, to be contrary to the public interest
So the CFTC may ban certain prohibited categories. With this statutory authority, it has decided to take advantage of its power to the maximum extent possible and create a blanket ban on all markets that involve “terrorism, assassination, war, gaming, or an activity that is unlawful under any State or Federal law.” Prediction markets for elections are therefore banned because, according to the CFTC, they are a type of “gaming,” that is, gambling. To repeat, and summarize for those whose eyes gloss over when faced with legalese, the steps are
Congress says the CFTC can prohibit event markets that involve “gaming” if it’s in the public interest.
The CFTC says fine, we ban all gaming.
The CFTC says that prediction markets are a kind of gaming, and therefore the default is that they’re banned.
Sometimes, institutions have been able to get exceptions to this general prohibition. In 2014, the CFTC sent PredictIt a letter saying that it could operate a non-profit market that could be used for research purposes only. Late last year, the agency announced it would withdraw that letter as of February 15, 2023, which PredictIt argues was an action that was “arbitrary and capricious.” I'm currently part of the resulting lawsuit.
As is common in the modern administrative state, Congress has outsourced what one might think would be its own functions. It simply once said that the CFTC has the option of banning certain categories based on the public interest. It leaves the CFTC to decide how to define the categories themselves, along with how it thinks about what the “public interest” actually means. It also can decide whether or not to enforce its regulations in individual instances. One can see this in the original No-Action letter sent to PredictIt.
Based upon your representations concerning the purposes and manner of operation of your proposed market for event contracts, the Division does not believe that operation of this proposed market without registration as a DCM, FBOT, or swap execution facility (“SEF”), or without registration of its operators, would be contrary to the public interest. The Division’s conclusion is based upon the facts that, among others, your proposed market for event contracts has been designed to serve academic purposes and the operators will receive no compensation. Furthermore, the Division would allow the University’s four proposed variations from the IEM model, as discussed above, because each is intended to produce more accurate results, which would promote the educational public interest purpose of the project while maintaining the small-scale, not-for profit nature of the proposed market.
There is some strange logic embedded in this paragraph, namely that no one making a profit means that a system is more likely to be in the public interest. Moreover, since the CFTC considers producing accurate results to be in the public interest, why does it seem to prefer low limits on the number of contracts allowed, which is likely to reduce accuracy? Regardless, the original PredictIt letter has been withdrawn, and it’s now up to the courts to decide whether we will still be able to have even the limited freedom that the CFTC has granted for the last nine years.
It’s All up to Five People
Prediction markets have the potential to revolutionize knowledge production and change the marketplace of ideas forever. One can imagine a world where pundits speak in terms of probabilities and confidence intervals, polling results and hot takes are judged against market based numbers, and individuals gain reputations for being correct rather than telling people what they what to hear or poisoning public discourse with hysterical lies.
Whether prediction markets are allowed to do this depends in the immediate future on the actions of the CFTC. The agency is run by five commissioners. By tradition, three of the five at any one time belong to the current president’s party, and the two others belong to the opposition party. Here are the current commissioners.
Unless and until Congress or the courts step in (more on that below), the future of human knowledge production will be shaped by these individuals. There has been so much work done trying to evangelize on behalf of prediction markets, yet if you could reach three of these five people it would matter more than convincing millions of fellow citizens.
The current path that the CFTC has taken isn’t without controversy, even among past and current commissioners of the agency. Brian Quintenz, a former CFTC commissioner, says that classifying prediction markets as a form of gaming results from a “blatantly incorrect reading of the statute.” Current commissioner Caroline Pham agrees that the agency has overstepped its authority. If two more commissioners take the same position, we could have prediction markets.
Each CFTC commissioner has a Twitter account. They are linked to below.
Chairman Rostin Benham (6.7K followers)
Kristin N. Johnson (1.3K followers)
Christy Goldsmith Romero (648 followers)
Summer Mersinger (688 followers)
Caroline Pham (11.6K followers)
Across five individuals, they have fewer than half of my Twitter following, and less than a third of prediction market enthusiast Robin Hanson. Even if Robin and I are more entertaining, on this topic CFTC commissioners matter much more than either of us. With follower counts that small, any significant Twitter activity directed at them and advocating for a position is likely to get their attention. I somewhat hesitate to direct you to their accounts, since Twitter can be a pretty vicious place, but I suspect that individuals interested in legalizing prediction markets and smart enough to know they need to influence CFTC commissioners will make their case in a polite way. Some effective altruist might do well to fund a psychological study on these individuals and see what is the most promising path towards convincing at least three of them to become pro-prediction market.
What Else Can Be Done
Besides trying to change the minds of CFTC commissioners, there are other ways to potentially legalize prediction markets. This section is an appeal to people who work in government, media, and other areas of life to press the cause, with ideas about how they can do so.
Congress and congressional staffers
Congress could step in any time and make clear that, no matter what the previous statute said or how it was interpreted, “gaming” does not mean prediction markets, which are henceforth legal. I’m no expert on congressional procedure, but I suspect that this is the kind of thing that a legislator could slip into a bill without much opposition if he made it a priority. I know some congressional staffers read this newsletter, and if you can get your boss to take up the cause it’ll make you a hero to me and other intelligent people across the globe. If prediction markets revolutionize the world, and I think the technology is so powerful that it certainly will at some point, you will go down as an important historical figure. I will help make sure your name doesn’t die.
This is thankfully not a partisan issue. Generally, Republican-appointed CFTC commissioners have been seen as more friendly to betting markets. But last fall, Congressman Richie Torres, a Democrat from New York, along with five progressive activists and journalists, sent a letter to the CFTC telling it that “prohibiting these markets doesn’t protect election integrity; it actively undermines it by furthering polarization, worsening the public’s understanding of our democratic process and promoting unsafe, black market exchanges.” The Vox crowd is also supportive, putting it on the same side as National Review, as is Jason Furman, formerly chair of President Obama’s Council of Economic Advisers.
Simon Bazelon and Matt Yglesias have written about the “Secret Congress,” which refers to the ways in which lawmakers often reach across party lines to make major policy changes without much media coverage. The New York Times recently reported on the last omnibus spending bill of 2022 including substantive changes to health care policy, including extending Medicare coverage of telemedicine. Intelligent people from across the political spectrum have recognized the benefits of prediction markets and the fact that most arguments against them are quite silly. Opposition to legalization seems relatively passive and muted. This makes prediction markets an almost ideal issue for the Secret Congress to get to work on.
Judges, law clerks, and law professors
The CFTC’s actions, like those of all government agencies, are reviewable in court. Legal processes are complex, but if you’re a judge and get the right case, you can ideally hand down a broad ruling saying that prediction markets must be legal. The low-hanging fruit here is simply ruling that by banning such a clearly beneficial technology, the CFTC is going against the statutory language saying that it can only ban derivatives or swaps that are against the public interest, since there’s literally no rational argument against prediction markets. While this may seem like an exercise of arbitrary power, I assure you, this is what judges do all the time, interpreting phrases like “public interest,” “arbitrary and capricious,” “rational basis,” etc. according to their own moral and political judgments. It’s what the administrative state does too, meaning that a way to think about our system is as one where federal judges pay deference to but ultimately outrank agencies. But for an agency action to be overruled, something has to come before the judiciary in the first place, and that depends in large part on which lawsuits are filed by businesses, public interest firms, and other litigants.
In addition to ruling on the question of public interest, a court could also rule that the CFTC has interpreted the word “gaming” wrongly and it doesn’t apply to prediction markets, so there is no authority to ban them. For another potential path to take, see this law review article arguing that prediction markets are protected under the First Amendment. A judicial ruling to this effect would preempt any other possible legislation or regulatory action that could be used to stop prediction markets in the future. I don’t care how you do it, just get us to the right outcome somehow. To law clerks: everything I said above to congressional staffers applies to you. This could be the most important work of your life. If you’re a law professor or other legal scholar, it would probably help to write some pro-prediction market law review articles. Judges like to have a “literature” to rely on to make their decisions, as do regulators. And as implied above, if you work at a public interest law firm, this would be a great cause to take up.
Writers, journalists, and influencers
If you have any kind of audience or following, you should share this article. It can directly help achieve some greater good, which is different than most of my articles, where I try to make the world better in an indirect way by putting forward an argument I think is correct and hoping that by moving people closer to the truth something good will eventually happen.
We could use some high-quality journalism on what is going on at the CFTC and the nuts and bolts of efforts to legalize prediction markets. Here’s a Bloomberg article from May on Kalshi and its relationship with the agency. Today, the Washington Post did a story on the status of PredictIt, and received a statement from the CFTC about why it is shutting the website down that can only be described as embarrassing, hopefully highlighting that something has gone wrong at the agency. Good journalism should be fair but avoid “bothsidesism,” where one pretends all arguments are of equal validity. Therefore, reporters should present those trying to legalize prediction markets as obviously correct and doing something noble, while finding opponents of liberalization interesting for what cognitive biases they must have and what kinds of political pressures they must feel subjected to in order to take such an obviously irrational and anti-human position.
Of course, others might have different ideas about how to legalize prediction markets. This essay isn’t meant to be the definitive word on the subject, and perhaps reading it will stimulate more thought about what individuals can do to make a positive difference. Knowing a little bit about why prediction markets are illegal in the first place can hopefully help others do their part.
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