Prediction markets’ push into US stocks raises regulatory alarm bells

Fresh updates from the financial markets indicate that Prediction markets are fast becoming alternative venues for traders to wager on US firms like Tesla and Apple, raising concerns around investor protection and market oversight, according to independent data and regulatory experts.

The booming industry pioneered by Polymarket and Kalshi rose to prominence by allowing punters to bet on almost anything, including sports events, elections and military operations.

During the past year, they have expanded into more traditional Wall Street turf, offering tens of thousands of markets on stock moves, firm data and other corporate events that often drive shares, according to independent research and a Reuters review that shed more light on this fast-growing pocket of the industry.

While still tiny compared with the underlying equity market, equity-linked prediction markets are creating a new venue for speculating on US securities outside many of the investor protections and market surveillance rules that govern regulated exchanges. Legal experts warn that if the products keep grow quickly, they could eventually influence trading in the underlying shares and undermine regulators' ability to police the market.

"This is a new frontier for market structure. It's innovation on steroids," stated Yesha Yadav, associate dean at Vanderbilt University Law School, adding that watchdogs should be "urgent and creative" in addressing these new products.

Polymarket and Kalshi say they closely monitor for misconduct and routinely refer cases to US authorities and collaborate with regulators.

"Market integrity is central to how we operate," a Polymarket spokesperson stated, adding that the firm additionally makes strenuous efforts to block US users from its international platform.

The Securities and Exchange Commission declined to comment, while the Commodity Futures Trading Commission did not respond to a request for comment. The agencies have stated they are reviewing regulation of equity-linked prediction markets.

NVIDIA, ALPHABET AMONG MOST POPULAR STOCKS

Polymarket International rolled out markets on individual stocks last October, and traders have bet more than $220 million on around 31,000 equity-linked markets through early September, according to an analysis that blockchain research firm Allium prepared for Reuters.

Nearly 60% of that was on markets tied to individual stock moves, with Nvidia, Google parent Alphabet, Apple and Tesla being the most popular, while the rest was wagered on markets based on ETFs or stock indexes, Allium found. Those public firms did not respond to requests for comment.

Traders typically bet "yes" or "no" on a stock or index hitting a specific level by a certain date. One wallet Allium identified generated $175,000 in volume through roughly 1,300 trades on Apple, structuring positions to generate a small earnings regardless of whether the "yes" or "no" contract paid out.

Kalshi does not at present offer individual stock wagers, but on a given day offers around 2,500 markets on indexes and corporate "Key Performance Indicators" (KPIs), such as iPhone launches and Tesla deliveries, according to a Reuters review of Kalshi's website and data it provided. Kalshi did not respond to a Reuters request for trading volume data.

Though targeted at retail customers, prediction markets are additionally courting institutional market participants by marketing event contracts as alternative ways to hedge traditional economic and market risks. Unlike equity markets, prediction markets allow market participants to trade around-the-clock and to express multiple views on a firm and its performance. But they do not offer the same protections and rights, legal experts stated, while the vast majority of traders lose money, multiple studies show.

Polymarket International's offshore legal structure, which puts it largely beyond the reach of US watchdogs, additionally makes it tough for authorities to see what is happening in these markets, stated James Angel, finance professor at Georgetown University.

"That's obviously the kind of thing that our regulators should be having nightmares around," he further noted.

Polymarket's newer CFTC-regulated US exchange does not offer markets on individual stocks but does offer a handful of KPI markets.

REGULATORY OVERSIGHT QUESTIONS

The CFTC says it should oversee prediction markets because they are effectively dealing in derivatives contracts, but calls for the SEC to step in too are growing.

Under US law, contracts tied to a single stock are generally considered security-based swaps (SBS), a type of derivative overseen by the SEC and mostly restricted to professional market participants.

Some KPI contracts could additionally potentially qualify as SBS, legal experts stated, although a Kalshi spokesperson disputed that. A spokesperson for Polymarket stated the firm was working with the agencies on how swap and SBS definitions apply to novel event contracts.

The regulators in June jointly sought public feedback on these issues and whether one of them should be the primary watchdog. Traditional financial firms and consumer groups want the SEC to take the lead because it has the expertise.

"You could envision insider trading taking place in these KPIs just as easily as you could in the stocks," stated Ben Schiffrin, a former SEC official now directing securities policy at nonprofit Better Markets. Policing that is "the SEC's job," he stated.

Several lawmakers, including US Senator Adam Schiff, a California Democrat, have additionally boosted concerns around prediction markets.

In a statement to Reuters, Schiff stated Congress should not allow the industry to "sidestep America's securities laws by wrapping traditional financial products in the guise of prediction contracts."