Even Courts Cannot Stop Innovation

Nevada Casinos Are On Notice

There is a predictable path that follows when a groundbreaking innovation occurs. First, the incumbents ignore it. People will make fun of it. “Get a horse” is probably the best way to illustrate this phase in the innovation process.

Remember, the greatest innovations are where really stupid ideas that actually can work come together. That’s why it is easy to poke fun at great innovation in the beginning.

Venture capitalist Fred Wilson loves to hear how what he invests in doesn’t work at the earliest stages. Makes him think he has a winner.

As the innovation takes hold and more people wake up and adopt it, the big incumbents start to grumble. Maybe it is taking some small market share from somewhere. It doesn’t hurt, but it stings a bit.

The incumbents get into their meeting rooms and discuss it. If they were to use Contio, they might make more progress.

The incumbents start to call their lobbyists. “Shut this down.”, they say. The lobbyists go to the regulators and politicians and tell them to shut it down. The lobbyists offer up several paths for this to happen. Look at what happened with cryptocurrency in the Biden Administration. Gary Gensler, head of the SEC, listened to the lobbyists and he bankrupted three banks in the process of shutting down the off/on ramps between crypto and fiat currency. Elizabeth Warren and other legislators were loud and proud in denouncing cryptocurrency.

Frankly, they had some tailwinds. There was a lot of fraud, and still is, in cryptocurrency. Other innovations that are less controversial are not rife with fraud.

In the case of companies like Uber or Airbnb, regulators and legislators used the power of government to try to tax or regulate them out of existence. Wait until you see what happens with driverless taxis.

The last stage of innovation is “Sue the Bastards.” The big incumbents take the innovation to court and try to stop it.

In my home state of Nevada, we are seeing that exact path play out when it comes to event betting. I found this blog when I was researching some things happening with Bitnomial. They wrote about how Nevada is kicking a hornet’s nest. It’s a detailed read.

Nevada’s Gaming Control Board is extremely powerful. After all, the state and cities generate most of their revenue from gambling and entertainment. For years, no one else had sports gambling, and it allowed organized crime syndicates to establish gambling dens around the US. Today, much of that has moved online to your phone. You can bet on anything when it comes to sports.

When I went to the Kentucky Derby a few years ago, I couldn’t even use my phone to make bets. I had to physically go to the window. That’s because I was a citizen of Nevada. It was the first time I realized how heavily regulated Nevada gambling is. My kids, who lived in other states, could use their phones to make all kinds of bets. My daughter bet the 80:1 shot for what it is worth.

The issue at hand is event betting or prediction markets. These are different than betting a game or playing a casino game like craps. You might have heard of Kalshi or Polymarket. Prediction markets are incredibly efficient. I wrote about them here before the Presidential election. Academic economists love them and study them. They write research studies about them.

Brogan Law wrote:

On March 4, the Nevada Gaming Control Board ordered the prediction market platform Kalshi to cease-and-desist from offering event-based contracts in Nevada. On first impression, this letter is merely bizarre—Kalshi is a federally regulated entity offering these contracts legally. In unpacking the implications, however, it is clear that this could go far beyond a letter and redefine the regulation of gambling in the United States. How the parties will play it remains to be seen, but if they choose war, this letter could set up a generational battle between state and federal authority to regulate these markets.

Nevada is going to lose this fight in court. If Nevada legislators want to fight it in the legislature, they will lose, too. That’s true if it’s state legislators in Carson City or in Washington, DC.

Why do I think that? My experience in regulated markets. I was a commodity trader for 25 years and served on the board of CME, the largest exchange in the world. We used to lobby Congress about a lot of different issues when it came to contracts and trading.

Kalshi is US-based. They did the right thing and became a regulated entity by the Commodity Futures Trading Commission (CFTC). It is extremely arduous to go through the steps to become a Designated Contract Market (DCM) exchange. Kalshi did that. I saw how the CFTC operates with CME, and I am an investor in Bitnomial, which went through the same process Kalshi did. When I say “extremely arduous”, I am understating the time and energy needed to trod the path, and the amount of money it takes to climb it.

Polymarket is not US-based. It’s also not regulated. It uses blockchain technology to power its prediction markets. Brogan Law writes: Polymarket was publicly censured in 2021 by the CFTC, and signed a settlement which obligated it to “cease offering access to trading in markets displayed on Polymarket.com, unless such offering, solicitation or trading complies with the Act.” So it moved its headquarters to Panama and geofenced US users.

Remember, innovation that is great will be adopted worldwide. The internet army is a gigantic army. When something is adopted, no country can totally stop it. Polymarket stopped it in the US, but it’s thriving everywhere else.

Kalshi offered prediction markets on political elections. The CFTC fought them, but Kalshi won. In the early 2000s, there was an academic site called the Iowa Prediction Markets that made markets on political elections and policy. It was purely academic, and the money that could be wagered was heavily restricted. But, it turned out it was pretty accurate anyway. Kalshi took that concept and is trying to go big with it.

If casinos wanted to compete, they’d build out prediction market books, similar to a sports book. Instead, they seem to be fighting it. When I was on the board of CME, we talked about potential competition with prediction markets. What if someone were to offer a prediction market in economic releases like unemployment? Would it impact exchange volume?

Crypto.com saw Kalshi’s win and began offering sports contracts. That is a big deal to the Nevada Gaming Industry, which reaps billions and billions in profit off sports betting.

The Biden CFTC didn’t do much about it since they were on their way out. Legally, since Crypto.com is a regulated DCM, they can list whatever contracts they want. It’s called “self-certification”. The CFTC can kill the listing, but there is a process. It is not clear what the Commodity Exchange Act (CEA) says about self-certification of sports betting-type contracts. It’s never been done on a regulated exchange before.

Remember, all these kinds of certifications and regulation is done on the federal level. I am not a lawyer or a judge, but exchanges fall under precedents like the Commerce Clause, the Supremacy Clause, and other settled law. Hence, regulation of them falls to the federal government, not state governments. Insurance and banking are different. But exchanges are broad, and participation in them isn’t dependent on local idiosyncrasies.

For example, the state of Nevada cannot regulate how or what kind of contracts are traded on the Chicago Mercantile Exchange or the New York Stock Exchange. The Feds can.

Kalshi also began offering sports contracts. Crypto.com is a competitor, so it makes sense that they would compete.

Nevada jumped squarely into the void. Think of a child jumping into a puddle after a rainstorm. Brogan writes: Nevada states that “offering event-based contracts in Nevada is illegal”, that offering these contracts is a “class-B felony” and that “even if Kalshi were to possess a nonrestricted Nevada gaming license with sports pool approval, the company’s offering of event-based contracts on election outcomes would still violate Nevada public policy.” Nevada then attempted to order Kalshi to “cease and desist offering any event-based contracts in Nevada”

The regulation stage of trying to stop innovation.

In the Brogan Law blog I linked to, he talks about venue. Kalshi and any other company involved in gambling need to do all they can to have the venue outside of Nevada federal courts. The state of Nevada will do all it can to keep it in Nevada state or federal court. It’s not clear which venue will prevail initially, but when the case gets to the Supreme Court, it won’t matter.

Brogan gives decent advice on going to court because of one state unnecessarily increasing burn rates on a startup. Besides, Nevada doesn't have a huge population, so not getting that market isn’t a killer. The lotto grows in value, and Nevada doesn’t participate.

Brogan further advises any company engaging in prediction markets to 100% avoid Nevada until a decision is reached.

Brogan does offer advice for Kalshi. He says they ought to go at Nevada’s Gaming Board head-on. I think, given the type of business Kalshi is in, he is correct. Nevada has no say over Kalshi’s business or business model. What Nevada’s Gaming Board is attempting to do is not that much different from what the taxi driver medallion lobby tried to do to Uber/Lyft or the hotel industry tried to do to Airbnb.

This will become a Supreme Court case involving state regulators, federal regulators, and innovation.

But if Nevada’s casinos were smart, they’d initiate prediction markets and event betting now. This is where the “corporatism” of the Nevada casino shows. They aren’t as entrepreneurial or risk-taking as they used to be. Everything is measured, calculated, and given a probabilistic chance of success. Corporations do that, and that’s why startups come and topple them. Maybe the casinos should buy one of the established startup companies engaged in prediction markets and hit the ground running, rather than build it themselves.

That’s a business decision based on costs, internal hurdle rates, customer acquisition costs, and other factors we can’t know exactly.

What I think will happen is that Brogan is correct. Nevada will lose this fight, and it will cost the state money to engage in the fight. Much better to embrace the innovation and keep your market going than fight it and lose.