Is an Event an Occurrence?

One Judge Thinks They Are Separate

Don’t know about you, but I am closely following the Prediction Markets litigation and development. Prediction markets are super interesting to me. It’s not because of the sports betting aspect, more on that later. It’s because of the role they can play to make the entire economy and the way business works more efficient.

Our entire international system of regulation over businesses could be upended quite a bit by a good prediction market.

Yesterday, Trump’s Treasury Secretary Bessent said he will institute price floors to combat China in the ongoing trade war. Bessent is smart enough to know they won’t work, or that they are just the little Dutch boy putting a finger in the dike. Price floors, even when they are backed by statistical and mathematical research, are centrally planned devices that screw up markets. The price ceilings we have courtesy of the federal government in the medical market are similar, except they cause a different kind of market distortion.

Trump might have done a good job with tariffs and the EU, along with other countries, but his strategy is not working with China.

A refresher from John Cochrane at The Grumpy Economist. It applies to everything, not just the health market.

The late great Ed Lazear told a story of visiting Gosplan, the Soviet price-setting agency. He found a copy of the Sears Catalogue. Gosplan, having no idea what prices to set on its own, used the Sears Catalogue. There is no Sears Catalogue for Medicare.

What if there were a prediction market for the price of rare earths instead of centralized governments quibbling over their price? We’d get more transparency and less volatility.

In business, prediction markets can be extremely powerful. One of the most challenging aspects of bringing a product to market is setting a market-clearing price that aligns with the company’s ability to produce the product, the distribution chain’s capacity to stock and resell the product, and the consumers’ desire and ability to purchase and afford it.

A properly structured prediction market could provide clarity to that process and lessen the chance of a mistake.

After all, since we know that today’s stock prices incorporate all available public information and speculation about the future discounted back into today’s price, isn’t the stock market sort of a prediction market? The P/E ratio of a stock is a prediction market for sure. A rise or drop in the price of a stock certainly sends a signal to the market about the underlying health or expected potential for future growth of the company.

We are all aware of prediction markets for politics. Politicians detest them. It makes it harder to get your message out and harder to raise money if you are heavily predicted to lose. Politicians do not like to be ignored, and if they are heavily favored to lose, they can be ignored. The market can get spicy when it is close, and that heightens competition in the underlying market. Increased competition brings more transparency. It also forces the candidates to up their game.

But what about athletics?

I read this case, which made its way through the Massachusetts courts. The casinos are taking their case to state courts. The prediction market companies are going to federal oversight agencies and federal courts. This makes sense from both sides’ perspectives strategically.

Essentially, what it will boil down to is a states’ rights vs federalism case. The US federal government decided long ago to let states regulate their own gambling. This made a lot of sense because there was no internet or virtual way to gamble when initially decided. The internet wasn’t even contemplated back then. Borders mattered.

Gambling is regulated by a single state. Prediction markets are regulated by the Commodity Futures Trading Commission (CFTC). Hence, prediction markets have different standards and can fall under the Commodity Exchange Act of 2000 (CEA). I was on the CME Board during reauthorization. It was a big deal.

Why?

At the time, there were regulated futures markets. Plain vanilla contracts on an exchange that had a designated contract market (DCM) and designated clearing organization (DCO). Lately, many companies in the prediction market space have gotten approval from the CFTC to operate both a DCM and a DCO. The licenses are not as rare as they used to be.

In 2000, outside of the futures market, there were OTC derivatives markets. In interest rates, swaps were in the trillions of dollars of notional value, while futures were in the billions. There was a risk that a lawsuit could be filed, and a judge would rule that the privately traded contracts worth trillions in notional value would be null and void, cancelling them all.

The debate started around 1998 and was completed in 2000. The CEA Act came into being, and it gave legal certainty to the OTC derivatives space. That eliminated any risk of it suddenly being flushed away.

I give you this background so you can understand the ongoing lawsuits between casinos and prediction markets.

Within that act, they defined who could trade swaps and who couldn’t. It also spelled out the role of the individual states as it pertains to swap facilities.

Whenever it shall appear to the attorney general of any State, the administrator of the securities laws of any State, or such other official as a State may designate, that the interests of the residents of that State have been, are being, or may be threatened or adversely affected because any person (other than a contract market, derivatives transaction execution facility, clearinghouse, floor broker, or floor trader) has engaged in, is engaging or is about to engage in, any act or practice constituting a violation of any provision of this chapter or any rule, regulation, or order of the Commission thereunder, the State may bring a suit in equity or an action at law on behalf of its residents to enjoin such act or practice, to enforce compliance with this chapter, or any rule, regulation, or order of the Commission thereunder, to obtain damages on behalf of their residents, or to obtain such further and other relief as the court may deem appropriate

and

(7)Nothing contained in this section shall prohibit an authorized State official from proceeding in State court on the basis of an alleged violation of any general civil or criminal antifraud statute of such State.

It is this provision that casinos are using to get standing in court to sue, and sue in state courts where it could be assumed they have more favorable odds of winning. Hey, maybe there should be a prediction market on the outcome?

Where this gets very sticky to me is in a recent ruling by a Nevada judge. In a recent State of Nevada vs Crypto.com case, his decision was that the contracts offered by Crypto were not swaps. Since they weren’t swaps, they were not regulated federally by the CFTC and fell under individual state regulation.

How did he get there?

The judge defined the difference between an “event” and an “occurrence”. To simplify, if there is a boxing match, the match is the event, and the outcome of the event is the occurrence.

Appellate attorney Andrew Kim has a great analytical thread on X regarding this case. In a separate case, prediction market Kalshi makes this point: If as the district court maintained, states remain free to apply their gambling laws even to DCMs, states would be free to regulate all event contracts, or even all futures contracts-which after all can be characterized as readily staking something of value on a future contingent event.

The CEA explicitly states that states do not have any sway over derivative markets.

This will become a Supreme Court case for sure. However, legislators in Congress might be prodded to amend the CEA of 2000. However, because of the changing landscape since 2000, amending it could invite a new can of worms into the fight. The initial fight was not only getting legal certainty on swaps, but also a big tug of war turf battle between the CFTC, SEC, and other financial regulators over who got power and say over what and where. Given that in the last 25 years innovations such as cryptocurrency have been brought into the fold, it’s not beyond the realm in our highly politicized environment to think that old scars will reopen and turf wars will be fought again, leaving the financial industry uncertain until they are solved.

States could also amend gambling regulations. Don’t count on that because there is a lot of money at stake. The money isn’t confined to casino cash flows but also the taxes states collect and redistribute. Hence, state budgets are threatened by the success of Prediction Market companies to take market share away from casinos.

While we mortals might want an easy common-sense solution to the issue, that is not how things work in Washington, DC, or in statehouses.

The legal profession often does its best to defy common sense. My hope is in the Prediction Market resolution, that doesn’t happen.

From the Prediction Market companies’ perspective, strategically, it makes a lot of sense to want to go into sports betting. It’s easily understood. It already exists with a population of active participants. Customer acquisition costs are lower. It is low-hanging fruit. Plus, the market size is huge when it comes to both eyeballs and dollars.

It’s much easier to list a sports-type contract than it is to go through a sales process with an independent corporation to set up a prediction market it might need for business.

You can also see it from the traditional casino perspective why they want to keep the prediction market companies out and why they see a difference between a sports betting contract and a prediction market for politics or what the unemployment rate might be next month.

As Kim points out, what is the difference between an over/under bet and a swap? It is a solid point. Predicting the outcome of the actual game, State U beats Directional U, could be categorized as a straight sports bet. A plain vanilla futures contract, if you will. But all the gimmick bets seem to resemble swaps, don’t they? They are extended bets on the underlying, similar to an interest rate futures contract and a swap that uses said contract to settle. Of course, a major difference is that the casino sets the line centrally and takes the risk, where a prediction market or futures exchange is the middleman between all the different players.

I do think there is a difference between athletics, politics, and business when it comes to prediction markets. In politics and business, I think the underlying statistics that are used have less variance, and therefore, outcomes are more certain. Athletic outcomes might seem certain, but if you watch Bad Beats on SportsCenter with Scott Van Pelt, you will see that often they are not.

I do like the idea of the crowd trading the market when it comes to athletics. It’s decentralized and distributed, unlike the OTC model that has been used by casinos (and the Mob when gambling was illegal) for generations. It is easier to manipulate the centralized OTC spread than a decentralized market-based spread. Ask Billy Walters.

Walters used to move the spread one way with money and rumor, then go in and bet big the other way and make millions if he was right. Billy was restricted, though. A casino had to accept his bet because if it were too large, they might not accept it. Walters’ move the line strategy is almost impossible to do in a market where the crowd sets the spread, because for every buy order, there is a corresponding sell order. It’s a zero-sum game. If he wanted to bet huge, someone would have to take the other side.

In the 2024 election, the French Whale was able to accumulate a huge position betting on Trump. There were enough sell orders for him to accumulate the position. He might not have been able to accomplish this if the bet were through a casino, since the casino would have been on the hook for the risk. They’d have had to move the line in their favor, and maybe the Whale doesn’t bite.

Courts can and will decide this. It would be far better for legislators to come to the table and come up with a stricter definition of terms that would give regulators clarity when it comes to innovations like prediction markets. That would invite lobbying, and the outcome wouldn’t be objective, but subjective.

It seems to me there is incredible value in prediction markets being able to interact with everything, except sports. Uncovering what people think is hard, and predication markets structured properly are amazingly proficient at that. Sports outcomes are very random, and frankly, when it comes to advancing and improving living standards for human life, betting on sports doesn’t make a difference. It is pure entertainment.

I won’t hold my breath on legislators achieving an objective outcome anytime soon.