The Erosion of Trust in Prediction Markets: Why Polymarket's In-House Trading Could Undermine Its Valuation and Growth

Prediction markets have long been heralded as a novel mechanism for aggregating collective wisdom, offering real-time insights into the probabilities of real-world events. Polymarket, a leading player in this space, has positioned itself as a transparent and innovative platform, leveraging blockchain technology to democratize access to speculative trading. However, recent developments-particularly the company's pivot toward in-house trading-threaten to erode the very trust that underpins its value proposition. As Polymarket navigates regulatory approvals and strategic expansion, its shift toward practices akin to traditional sportsbooks raises critical questions about market integrity, legal exposure, and long-term sustainability.

In-House Trading and the Sportsbook Comparison

Polymarket's exploration of an internal market-making team, which would trade directly against users, marks a departure from its foundational identity as a neutral prediction market according to Coindesk. Critics argue this move aligns the platform with the operational models of traditional sportsbooks, which profit by setting odds with an embedded house edge. Harry Crane, a statistics professor, has labeled the strategy "short-sighted," warning that it could damage Polymarket's reputation and create conflicts of interest. By embedding a financial incentive to profit from user activity, the platform risks alienating participants who view prediction markets as tools for aggregating genuine market sentiment rather than engaging in high-stakes gambling.

This shift also invites comparisons to Kalshi, another prediction market operator recently embroiled in a class-action lawsuit over similar practices. While Polymarket has yet to face direct legal action, the precedent underscores the reputational and regulatory risks of conflating prediction markets with traditional betting platforms.

Legal and Reputational Risks

The legal landscape for prediction markets in the U.S. remains fragmented, with federal derivatives regulations coexisting uneasily with state-level gambling laws. Polymarket's recent CFTC approval to operate as a regulated derivatives market-a significant milestone-has not resolved tensions with states like Connecticut, which issued cease-and-desist orders to three platforms, including Kalshi, for offering unlicensed sports event contracts. These actions highlight the precarious position of prediction markets in jurisdictions where lawmakers view them as gambling rather than financial instruments.

Polymarket's in-house trading strategy could exacerbate these tensions. By adopting practices that blur the line between prediction markets and sportsbooks, the company may inadvertently trigger stricter state-level scrutiny, even as it complies with federal standards. Such regulatory whiplash could stifle growth and force costly operational overhauls.

Artificial Trading Volume and Market Integrity

Compounding these concerns is a study by Columbia University researchers, which found that approximately 25% of Polymarket's trading volume over the past three years consisted of artificial activity, such as wash trading. In sports-related markets, this figure rose to nearly 50%. While not unique to Polymarket-such practices are common in many speculative markets-the implications for trust are profound. Artificial volume distorts the perceived liquidity and activity of markets, undermining their utility as barometers of real-world probabilities.

This erosion of integrity is particularly damaging for a platform that markets itself as a transparent, data-driven alternative to traditional financial markets. If users begin to question the authenticity of trading activity, Polymarket's ability to attract institutional investors or serve as a reliable indicator of public sentiment could be compromised.

Regulatory Compliance and Strategic Trade-Offs

Despite these risks, Polymarket's U.S. relaunch under CFTC oversight represents a strategic pivot toward institutional legitimacy. The platform's new mobile app, limited to a waitlist, and its focus on sports event contracts signal an effort to balance growth with regulatory compliance. However, the introduction of in-house trading introduces a fundamental tension: the company must now navigate the dual imperatives of generating revenue from user activity while maintaining the neutrality that defines prediction markets.

This tension is not insurmountable, but it requires careful calibration. For example, Polymarket could mitigate conflicts of interest by clearly disclosing its trading activities and implementing safeguards to ensure price-setting remains transparent. Yet, the absence of such measures-combined with the company's silence on these concerns-leaves room for skepticism.

Implications for Valuation and Growth

Polymarket's valuation has been buoyed by its technological edge and institutional backing, but these advantages may prove hollow if trust in the platform's integrity wanes. The company's unique proposition-aggregating real-time data through decentralized, user-driven markets-relies on the perception that its outcomes reflect genuine market sentiment. Artificial volume, in-house trading, and regulatory ambiguity all threaten to devalue this proposition.

Investors must weigh these risks against Polymarket's potential to scale. While the CFTC approval opens new avenues for growth, the company's strategic choices will determine whether it can sustain its position as a leader in a nascent but contentious market. The path forward demands a delicate balance: embracing innovation without sacrificing the transparency and neutrality that set prediction markets apart.

Conclusion

Prediction markets occupy a fragile space between financial instruments and speculative gambling. Polymarket's in-house trading strategy, while potentially lucrative, risks undermining the trust that has fueled its rise. As the company navigates regulatory approvals and market expansion, it must address the inherent conflicts of interest and ensure its practices align with the principles of transparency and integrity. For investors, the stakes are clear: the erosion of trust in Polymarket's markets could have far-reaching consequences, not only for its valuation but for the broader credibility of prediction markets as a whole.