Written by: TinTinLand

Why is it crucial to improve regulations now?

The market is one of the most powerful tools for aggregating and analyzing information, capable of distilling vast amounts of data into actionable insights. Prediction markets are a direct extension of this principle.

As the applications of prediction markets continue to expand, the urgency to correctly address related legal and regulatory issues has become increasingly apparent.

Imagine the integration of three technologies: prediction markets, artificial intelligence (AI), and blockchain.

Currently, AI agents can autonomously process large amounts of information and execute transactions; blockchain provides a permissionless, programmable underlying architecture for these AI agents to interact directly. The combination of the two signals a future where AI agents can be deployed on-chain to autonomously hedge commercial risks for various event contracts, adjusting their positions in real-time based on changing circumstances, with each transaction requiring no human intervention.

This is not a science fiction concept; the core technology has already matured, and what is currently lacking is the market infrastructure and clear regulatory policies to support its large-scale development. For example:

• A manufacturing company facing risks of commodity price volatility triggered by geopolitical events;

• A retailer whose revenue is affected by weather patterns;

• An insurance company seeking more refined hedging tools.

These entities can deploy AI agents to manage event contract positions in real-time on blockchain-based prediction markets, thereby hedging risks that are currently unhedgeable or only hedgeable through rough substitutes.

Far Beyond Risk Management

Its significance extends beyond just risk management. Prediction markets are essentially "information machines": a mechanism that transforms dispersed information into price signals reflecting collective intelligence. When AI agents participate on a large scale in these markets within an open blockchain architecture, a powerful system capable of efficiently forecasting real probabilities emerges. In this age of rampant misinformation and declining institutional trust, a market that can synthesize reliable probabilistic signals from human and machine intelligence may become a key information infrastructure of the internet itself.

However, if the regulatory framework continues to treat prediction markets as a "barely tolerated niche product," the above vision cannot be realized. The current rule-making of the CFTC will determine whether prediction markets can evolve into widely applicable risk management and information discovery infrastructures. Technology should not be constrained by outdated rules at its nascent stage.

What obstacles exist?

Well-developed and orderly regulated prediction markets have the potential to cover many areas of the global economy currently untouched by other markets, providing users with important risk management tools. For example, in the past, institutions wishing to hedge macro event risks with related assets were often forced to make two forecasts simultaneously: one predicting the event itself and the other predicting the correlation between that event and the traded asset. Any error in either would lead to a failure in hedging. Direct prediction markets combine these two forecasts into one, making hedging more precise and efficient.

Moreover, unlike polls or surveys (which typically capture momentary opinions, have limited samples, and use outdated methods), prediction markets are continuous, incentivized, and capable of unearthing deeper information. Participants back their judgments with real financial stakes, meaning the prices reflect true beliefs rather than arbitrary opinions. This makes them a valuable tool for identifying and hedging potential future event risks.

In particular, the application of blockchain technology in prediction markets is expected to lower entry barriers, increase speed, enhance transparency, and protect users through asset self-custody. However, several policy and regulatory barriers hinder the realization of these benefits:

• State-level regulatory interference

The inconsistent laws and regulations across states, along with the lack of coordinated enforcement actions by state attorneys general or gaming commissions, including cease and desist orders or even criminal charges, threaten the very foundation of prediction markets. These state-level actions not only harm residents who lose access to the market but also disrupt the overall market structure. Congress established "Designated Contract Markets" (DCMs) to unify national regulatory frameworks to avoid such situations, and prediction markets need similar consistent treatment.

• Contract settlement disputes

Prediction markets fundamentally deal with uncertainty. Therefore, there can sometimes be disputes about whether the underlying events associated with contracts have occurred. Although markets strive for clarity, there are practical limitations in simplifying complex realities into "binary (yes/no)" outcomes. To achieve scalable growth, prediction markets need better dispute resolution mechanisms.

• Manipulation and insider information

If individuals who can directly affect event outcomes or other insiders exploit their informational advantage at the expense of integrity, market trust will diminish. This requires effective coordination and market monitoring to eliminate bad actors.

• Ineffective enforcement of "special rules"

In its 2011 rule-making, the CFTC uniformly banned certain categories of event contracts (such as those related to gambling and war) without conducting a public interest determination as required by the Commodity Exchange Act (CEA).

This blunt approach is detrimental to users and enterprises and does not comply with the Administrative Procedure Act.

• Barriers to the use of blockchain technology

Although blockchain can bring advantages such as low costs and around-the-clock trading, current principles lack clear guidance on how to use blockchain in compliance.

Solutions

Reaffirm CFTC jurisdiction

Congress's original intention was clearly to set federal law above state law to prevent states from prohibiting the operation of DCMs. Binary options event contracts are a type of "swaps," which should fall under the exclusive jurisdiction of the CFTC according to the Commodity Exchange Act, and not be restricted by state gaming laws. This jurisdiction must be reaffirmed to provide a unified national regulatory pathway.

Improve contract settlement mechanisms

The CFTC and DCMs can look to the International Swaps and Derivatives Association (ISDA) "Determination Committee" model. This committee determines whether a specific event has occurred based on relevant definitions and terms. This model could help prediction markets establish better dispute resolution standards.

Prevent manipulation and insider information

Establishing a "restricted trader list" is a powerful tool for maintaining market integrity. Such lists can be created through Customer Identification Program (CIP) and KYC checks. Simultaneously, prediction markets can leverage the auditability of on-chain transactions to monitor suspicious trading activities in real-time. Furthermore, it is recommended that the committee considers cross-market surveillance arrangements and collaborates with professional organizations like sports integrity monitoring entities.

Effectively implement "special rules"

Certain contracts categorized under "special rules" have public value (such as geopolitical event contracts that are mature hedging tools; sports-related contracts that help businesses hedge price risks). The committee should conduct a comprehensive public interest determination rather than impose blind prohibitions; contracts should be permitted as long as they have been proven to serve the public interest.

Promote the development of blockchain prediction markets

Regulatory principles should adapt to the characteristics of decentralized networks. The CFTC should explore "conditional exemptions" or other compliance pathways to allow prediction markets to genuinely realize the technological benefits of blockchain.

Conclusion: The Right Time

The proposed rule-making announcement by the CFTC is an exciting signal that indicates the regulatory agency is ready to provide the clarity needed for prediction markets.

The CFTC has an excellent opportunity to unlock the potential of this market, and we look forward to the committee seizing this moment.

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