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This week, Judge Jia Cobb of the U.S. District Court for the District of Columbia ruled in favor of the prediction market Kalshi in its case against the Commodity Futures Trading Commission. As professionals in the space we believe Judge Cobb’s ruling could be among the most important in the history of prediction markets.
Aaron Brogan is the managing attorney of Brogan Law PLLC, where he specializes in cryptocurrency regulation and disputes. Matthew Homer is a VC investor and advisor to founders in the crypto space.
The CFTC, chaired by Rostin Benham, has taken an aggressive posture toward prediction markets. First, in January 2022, the Commission ordered the crypto-based prediction market Polymarket to pay a $1.4 million penalty and “cease offering access to trading in markets” in the United States. Next, In August 2022, the CFTC withdrew the more traditional, fiat-based prediction market PredictIt’s no-action letter — an agreement not to sue a company— in an attempt to shut down the platform.
Kalshi was next, but it had protection because it was registered legally as a regulated exchange (technically a designated contract market or DCM). Within this framework, Kalshi is entitled to self-certify “event contracts,” and the CFTC may only prohibit them where they are contrary to public interest and involve specific activities, including “war," “terrorism," and “gaming.”
In September 2023, Kalshi attempted to certify a market concerning which party would control each house of Congress. The CFTC quickly issued an order disapproving the contract and effectively prohibited Kalshi from listing event contracts based on political outcomes.
The CFTC argued that Kalshi’s political contracts involve gaming “because taking a position in the Congressional Control Contracts would be staking something of value upon the outcome of a contest of others [and] The Congressional Control Contracts are premised on the outcome of Congressional election contests.”
This week, in a memorandum opinion, Judge Cobb, a Biden appointee, disagreed, finding that “Kalshi’s congressional control contracts involve elections (and politics, congressional control, and other related topics) and not illegal activities or gaming.”
The CFTC did not accept this loss. Instead, at a hearing on Sept. 12, it argued repeatedly that this motion should be stayed pending appeal (a stay would mean that the contracts remained offline).
The CFTC argued that despite Kalshi’s win, the court should grant it a stay because “even a short listing of Plaintiff’s contracts” would cause “irreparable harm.” Late Thursday, the D.C. Circuit Appeals Court granted the CFTC a stay.
Why is the agency so worried about these contracts being listed for even a moment? The answer is that the Commission is engaged in so-called “midnight rulemaking.”
You see, perhaps recognizing the weakness of its arguments, the CFTC began hedging its bets in May — issuing a proposal to define “gaming” through its rulemaking power. In the notice, the Commission attempts to broaden the scope of gaming by defining it:
“as the staking or risking by any person of something of value upon: (i) the outcome of a contest of others; (ii) the outcome of a game involving skill or chance; (iii) the performance of one or more competitors in one or more contests or games; or (iv) any other occurrence or non-occurrence in connection with one or more contests or games.”
Agencies like the CFTC are “independent," meaning they do not answer directly to the President. However, the President is entitled to appoint the majority of the five commissioners from within his or her party, and it is typical for the Chair to resign when a new President takes office, as previous Chair Heath P. Tarbert did in 2021. This means that the Benham Commission became a lame duck when Biden dropped out of the election on July 21.
We know a Republican CFTC would take a less hostile stance to prediction markets than the current Commission because the current Republican Commissioners have told us so. Commissioners Summer Mersinger and Caroline Pham dissented to the Kalshi order and to the proposed rulemaking, with Commissioner Mersinger arguing “it is hard not to conclude [ ] that [the proposed rule] is motivated more by a seemingly visceral antipathy to event contracts than by reasoned analysis.” Similarly, Kamala Harris, should she win, will have an opportunity to set her own direction at the Commission.
The current CFTC knows this. If it conceded that Kalshi’s contracts are legal under the current rule, and waited for its proposed rulemaking, then the next administration could take a different stance. Instead, it is pulling every stop to prevent these contracts from ever being offered while it still can.
This is a problem. The Congressional Research Service has recognized that some consider midnight rulemaking concerning because “an outgoing administration has less political accountability compared to an administration faced with the possibility of re-election.”
There is a bright spot, though. The CFTC’s efforts may be in vain. Under Judge Cobb’s ruling, the proposed rule may not prohibit event contracts involving elections at all.
Judge Cobb found that the “a contract or transaction [only] ‘involves’ an enumerated activity if the event being offered and traded as part of that contract or transaction relates to that activity,” and the Kalshi contracts did not involve gaming. The proposed rule changes the definition of gaming to the “staking or risking of something of value on [e.g. the outcome of a contest],” but it does not change the “involve” language critical to Judge Cobb’s ruling. Because elections are not “the staking of value,” but rather the underlying contests themselves, under Judge Cobb’s rule, they are likely still outside the CFTC’s authority.
We won’t be certain until the appeals shake out, but even during “midnight rulemaking” some light may have appeared. If it turns out that Judge Cobb’s rule preempts the CFTC’s proposed rulemaking, election event contracts may now be completely legal.
We hope this marks a turning point in the regulation of these markets. In the past few years, there has been a concerning trend of some federal regulators opting to ban markets they disfavor, rather than fulfill their duty to regulate them. American consumers should be able to engage with well-regulated U.S. entities, even with novel products. It seems some regulators would prefer to push these offshore. In our view, this is not in the public's interest.
Note: The views expressed in this column are those of the author and do not necessarily reflect those of CoinDesk, Inc. or its owners and affiliates.