Prediction Markets
Definition
A prediction market is a venue where participants buy and sell contracts whose payout depends on the outcome of a future event, such as an election, an economic release or a game. The CFTC calls the products 'event contracts' and notes they 'have existed in U.S. regulated markets for more than two decades.' Prices move as traders buy and sell, and each contract settles at a fixed amount, usually $1, or zero once the outcome is determined under the market's rules.
Why it matters
A prediction market position is a short-dated contract with a fixed payout, not an investment with income or residual value. Returns depend on the price paid, fees, the market's rules and how settlement is determined. Investors should read the venue's rules and fee schedule, know who decides the outcome, and treat trading as a zero-sum activity before costs.
Common misconceptions
- •The venue does not guarantee outcomes; registration concerns how the exchange operates, not who wins.
- •The displayed price is not a guaranteed probability or an executable price for any size.
- •Positions can usually be sold before settlement, at whatever price the market then offers.
- •Trading is zero-sum among participants before fees; fees make it negative-sum in aggregate.
Technical details
Life of a trade
Read the market's rules: event definition, source and determination time.
Buy yes or no at the ask, or post a limit order.
Hold, or sell before close at the current bid.
Market closes; the outcome is determined from the named source.
Settlement credits $1 per winning contract and $0 per losing contract.
What the CFTC says customers are entitled to
Clear information about risks, commissions, fees and other costs.
Trading rules and contract terms, including payout, prices and 'how settlement determinations will be made, who decides, and how.'
Access to their funds and the right to complain to the broker, the exchange, the NFA and the CFTC.
How investors apply the term
Investors usually apply this term by tying the definition back to the controlling documents and then asking which cash flows, rights, restrictions, or valuation assumptions it changes. A useful review looks at the term alongside fees, leverage, liquidity, reporting frequency, and manager discretion rather than treating it as a standalone concept.
The practical diligence test is simple: identify who benefits if the assumption is wrong, who has control when conditions change, and what evidence the investor receives after closing. Terms that cannot be reconciled to documents, cash movements, and monitoring data should be treated as marketing shorthand until proven otherwise.
Frequently asked questions
- How do prediction markets work?
- A trader buys a position on an outcome at the current price, holds or sells it before the market closes, and is paid at settlement if the outcome occurs. The CFTC's example: a 'Will it rain tomorrow?' contract trades at 70 cents for yes and 30 cents for no; a trader who bought yes at 70 cents and it rains 'would earn a 30-cent profit when the contract settles,' while traders who were wrong 'would lose their investment.' The CFTC adds that 'taxes and fees may also affect a trader's return.'
- Who is on the other side of my trade?
- Another participant. The CFTC says regulated exchanges and intermediaries 'do not take a side of the trade. They provide a platform for trading and are not competing against you.' Affiliated market makers can still trade on a venue; the Kalshi review covers the one Kalshi discloses.
- How long have prediction markets existed in the US?
- The CFTC dates the first modern one to 1988, the Iowa Presidential Stock Market, which operated under a 1992 no-action letter. In 2004 the CFTC approved HedgeStreet as 'the first designated contract market (DCM) offering binary options'; the Dodd-Frank Act of 2010 gave the CFTC authority to prohibit certain types of event contracts.
- Are all prediction markets regulated the same way?
- No. CFTC-registered exchanges such as Kalshi operate as designated contract markets with rulebooks, surveillance and clearing. Polymarket's international markets run on a blockchain and are resolved by the UMA Optimistic Oracle, under which an outcome is proposed with a bond and can be disputed. Custody, dispute and legal protections differ, and are covered in later pages of this library.