The Democratic Party sweeps both houses, predicting a "tighter regulation" window for the market

Author: Zhou, ChainCatcher

In the U.S. midterm elections on November 3, the Democratic Party won both the House and Senate. Even before the official results were announced, prediction market platforms Kalshi and Polymarket had already predicted a Democratic sweep of both chambers as a highly probable event.

Kalshi officially stated that the trading volume related to the midterm elections exceeded $2.5 billion, about twice that of the entire 2024 election cycle. The CEO of Kalshi indicated that the platform's popular candidates won 479 out of the first 487 elections that had results, accounting for about 98%.

For prediction markets, this was another highlight moment following the World Cup, but the prediction markets that hit the results quickly became targets for the winning side.

According to Politico, long-time critic of prediction markets, Democratic Senator Jeff Merkley stated that with the Democratic Party regaining control of Congress, the time has come to push for legislation to restrict such betting. Maxine Waters, who is vying for the chair of the House Financial Services Committee, also promised to regulate predatory platforms, including prediction markets.

In fact, resistance to this industry had already begun before the elections. From Apple to Hollywood studios, several companies have recently prohibited employees from betting using insider information; multiple states have already sued Kalshi, with the lawsuits reaching the Supreme Court.

Why has this rapidly growing industry, supported by the Trump administration, become a target in just two years? What will the Democratic takeover of Congress bring to it?

Prediction Markets Enter the Trillion Dollar Era, Regulatory Boundaries Still Unresolved

The expansion speed of prediction markets this year has been astonishing. According to Artemis, the weekly trading volume for the entire industry was about $5 billion at the beginning of the year, rising to over $30 billion by the end of October. The trading volume for October reached $123.3 billion, breaking the trillion-dollar mark for the first time, with Kalshi accounting for about 80%.

Valuations have also soared. On October 29, Kalshi announced it had completed a $1 billion financing round at a valuation of $40 billion, led by Sequoia Capital and Wellington Management.

According to a September 1 report by The Wall Street Journal, Donald Trump Jr., who serves as a partner at investment firm 1789 Capital, plans to invest about $300 million in Polymarket as part of a $1 billion financing round led by 1789 Capital, which would value Polymarket at about $21 billion if completed.

On the regulatory front, election contracts were still in a gray area in the U.S. two years ago. Kalshi only received approval to launch related markets through litigation in the fall of 2024, while Polymarket was unable to serve U.S. users due to a settlement with the CFTC in 2022.

After the Trump administration took office, the winds shifted. Regulatory agencies generally supported prediction markets, clearing obstacles for their expansion in politics, sports, and stocks. Polymarket also returned to the U.S. market through a subsidiary holding a CFTC license.

Currently, prediction markets are regulated at the federal level by the CFTC. Both Kalshi and Polymarket operate as CFTC-designated contract markets in the U.S., and when launching new contracts, they can self-certify to the CFTC without prior approval. Polymarket's overseas main site is not subject to U.S. regulation and, according to the 2022 settlement agreement, cannot be open to U.S. users.

At the state level, sports betting is managed according to state laws. The disagreement lies in whether sports event contracts fall under the exclusive jurisdiction of the CFTC as financial derivatives or should be governed by state law as betting activities. To date, there has been no definitive ruling from federal courts, and at least 15 states have proposed legislation related to prediction markets.

However, of the five commissioner positions at the CFTC, only Chairman Michael Selig is currently in office. According to CNBC, some lawmakers are concerned about whether this agency, which has just undergone layoffs, can handle the rapidly expanding market.

Insider Trading and De Facto Gambling, The Cost of Growth Begins to Surface

As trading volumes continue to expand, two types of issues have gradually emerged.

The first is insider trading. Prediction markets allow betting on almost any event, and those with insider information naturally have an advantage, while weak regulation makes it easy to monetize that advantage.

The most emblematic case occurred in April this year. The U.S. Department of Justice charged Army Special Forces Sergeant Gannon Ken Van Dyke with participating in the planning of a January operation to capture Venezuelan President Nicolás Maduro and using classified information to bet about $33,000 on Polymarket, profiting over $400,000. This was the first time the Department of Justice filed criminal charges for insider trading related to prediction markets.

Similar suspicious trades are not isolated incidents. Research from the U.S. anti-corruption data coalition ACDC revealed structural reasons behind this. In the congressional election market on Polymarket's overseas site, the top 1% of wallets contributed about 70% of the trading volume, with 80% of the market's participating wallets being fewer than 100. As the number of markets increases, individual markets become thinner, allowing a few informed individuals to significantly influence prices.

The second issue is de facto gambling. Kalshi, leveraging its CFTC license, offers sports event contracts in many states where sports betting has not yet been legalized. States view this as a way to circumvent state law regulation and corresponding taxes under the guise of financial derivatives.

Ordinary users pay the price for this; Galaxy Research analyst Will Owens studied about 2.9 million accounts trading on Polymarket's overseas site at a manual pace and found that 69.2% ultimately lost money, with total losses amounting to about $339 million. The profit rate for traders focused on sports was only 25.1%, the lowest among all fields; those focused on technology and science had the highest profit rate, with the report suggesting that some of them might possess insider information.

Owens also pointed out that both platforms spend heavily on marketing, attracting precisely those with the poorest profit performance. According to Front Office Sports, Polymarket pays LeBron James $15 million annually to promote football-related prediction markets.

Both types of issues point to the same outcome. In this market, profits flow to the few with more information, while risks fall on ordinary players attracted by marketing.

Unable to Wait for Legislation, All Parties Have Already Cast Opposition Votes

As problems accumulate, voices of opposition have emerged from various parties even before the elections. The first to express their stance was the public; a poll conducted by Reuters and Ipsos in October showed that most American respondents believe betting on real events in prediction markets is gambling, with over 60% opposing betting on election outcomes.

Within the government, on October 20, U.S. Secretary of Defense Pete Hegseth issued a memorandum prohibiting Department of Defense personnel from betting using classified or unclassified non-public information, specifically naming Kalshi and Polymarket. He warned that adversaries are also watching the fluctuations in these markets. This ban comes from within the Trump administration, which has generally supported prediction markets, carrying significant weight. Following the elections, Apple and Hollywood studios also issued similar bans to their employees.

The strongest opposition comes from the states. The Attorney General of Utah filed felony charges against Kalshi and its two co-founders, Oregon sued Kalshi for tax recovery, and a federal judge in California approved a tribal application to prohibit Kalshi from offering sports contracts on the land of the plaintiff tribe.

The lawsuits between the states and Kalshi eventually reached the Supreme Court. In April of this year, the Third Circuit Court of Appeals ruled that the CFTC has exclusive jurisdiction over sports contracts, supporting Kalshi; in August, the Ninth Circuit Court of Appeals made a contrary ruling in a case in Nevada. On September 2, New Jersey applied to the Supreme Court for a writ of certiorari based on this.

The Supreme Court case files show that 11 amicus curiae briefs have been submitted in support of New Jersey, including submissions from 39 states led by Ohio and Washington D.C., 145 Indian tribes and tribal organizations, the NFL, and former CFTC Chairman Gary Gensler and former Senator Christopher Dodd. Among them, Dodd was one of the proponents of the Dodd-Frank Act of 2010, which significantly expanded the CFTC's regulatory authority over derivatives.

Democratic Victory Increases Pressure, The Real Variable Lies with the Supreme Court

This Democratic victory adds another layer of congressional power to the blockade. However, the congressional scrutiny of prediction markets had already begun when the Republicans controlled Congress.

In May of this year, James Comer, the chairman of the House Oversight Committee and a Republican, launched an investigation into insider trading issues in prediction markets, requesting Polymarket and Kalshi to explain how they identify abnormal trading.

After the Democrats took over, this type of oversight will only intensify, adding a layer of political motivation. Donald Trump Jr., the eldest son of Trump, serves as an advisor to both Kalshi and Polymarket, and his investment firm, 1789 Capital, has also invested in Polymarket. Politico believes that the Democrats' scrutiny of prediction markets may become a window to observe how they respond to the Trump family's affiliated businesses.

However, transforming oversight into legislation is not easy. The bill proposed by Merkley and Congressman Jamie Raskin in March of this year aims to prohibit betting on events such as elections, sports, wars, and government actions. Even if such a bill passes both houses, Trump could still exercise his veto power.

Aaron Klein, a senior fellow at the Brookings Institution, believes that the hard constraints of legislation are often overestimated, while the soft constraints of hearings and investigations are often underestimated. Congress does not have the authority to replace Selig, but it can apply pressure through hearings and can attach provisions in appropriations bills to limit the CFTC's use of funds for litigation or for developing new regulations.

These soft constraints are important because the CFTC's own position is not singular. On one hand, it has sued ten states, including Utah and Kentucky, defending its exclusive jurisdiction over sports contracts.

On the other hand, it has filed a civil lawsuit against Van Dyke and, according to Reuters, is also re-investigating whether Polymarket violated the 2022 settlement agreement that barred it from opening its overseas main platform to U.S. users. What the CFTC is truly defending is federal jurisdiction and a licensed operating model.

If Congress restricts the CFTC's funds for litigation, it may also lose its confidence in confronting various states. If the Supreme Court accepts the case from New Jersey and supports the states, the logic of federal jurisdiction that Kalshi relies on for expansion across the U.S. will be directly shaken.

Kalshi was originally scheduled to submit its defense on November 9, but the Supreme Court has approved an extension until December 7. At this pace, the Supreme Court will not decide whether to accept the case until early next year at the earliest.

Prediction Markets May Become the Next Cryptocurrency Industry?

Politico cites a former Wall Street regulator as saying that on the Democratic congressional agenda, prediction markets may become the new cryptocurrency industry.

The cryptocurrency industry once expanded rapidly in an environment lacking regulations, only to be repeatedly pulled back amid enforcement pressures and legislative games.

Now, prediction markets have reached a similar crossroads, with growth continuing, costs becoming apparent, and containment extending from businesses and states to Congress and the Supreme Court.

For an industry that can accurately predict elections, what may be harder to predict is its own regulatory outcome.