The Legal and Regulatory Battle Over Prediction Markets and Its Implications for Investors

The rise of prediction markets in the United States has ignited a fierce legal and regulatory tug-of-war between state authorities, tribal governments, and platforms like Kalshi and Polymarket. As these platforms process billions in trading volume and attract institutional investment, their long-term viability hinges on resolving a critical question: Will federal preemption under derivatives laws shield them from state-level enforcement, or will states impose their own gambling regulations? For investors, the answer will shape the future of a market projected to become a trillion-dollar asset class.

The Legal Frontlines: Federal vs. State Jurisdiction

At the heart of the conflict lies a clash over regulatory authority. Prediction market operators argue that their platforms operate as financial derivatives exchanges under the Commodity Exchange Act (CEA), overseen by the Commodity Futures Trading Commission (CFTC). Kalshi, for instance, has sued regulators in Nevada, Maryland, and New Jersey, asserting that its contracts are federally regulated and preempted from state oversight. This argument rests on the CFTC's 2021 authorization of Kalshi's operations, which classified its event contracts as "binary options" under the CEA.

However, state regulators and tribal authorities counter that these platforms function as unregulated gambling operations. In Maryland, a court rejected Kalshi's request for an injunction, ruling that Congress did not demonstrate a "clear and manifest purpose" to preempt state gambling laws when drafting the CEA. Similar challenges have emerged in Nevada and New Jersey, where regulators argue that prediction markets tied to sports and political events fall under state gaming statutes. Tribal governments, including the Oklahoma Indian Gaming Association, have also sued Kalshi, claiming violations of the Indian Gaming Regulatory Act and unauthorized operation on tribal lands.

The legal battle has escalated to the federal level. New York's Assembly Bill 9251, the ORACLE Act, seeks to create a state-specific regulatory framework for prediction markets, imposing age restrictions, deposit limits, and prohibitions on sports and political event contracts. Meanwhile, Pennsylvania and other states are exploring legislative responses to address consumer protection and tax revenue concerns. These efforts highlight a growing trend: states are increasingly treating prediction markets as a regulatory gap to be closed, not a financial innovation to be embraced.

Market Growth Amid Legal Uncertainty

Despite the legal headwinds, prediction markets have experienced explosive growth. By late 2025, Kalshi had captured 65% of the U.S. prediction market share, processing $500 million in weekly trading volume and maintaining an average open interest of $189 million. Polymarket, once dominant with 95% market share in late 2024, saw its share decline to 37% by September 2025 but still raised $2 billion in October 2025 at a $9 billion valuation. This growth has been fueled by high-profile partnerships, such as Kalshi's integration with TRON and Phantom, and Polymarket's acquisition of a CFTC-regulated derivatives exchange.

Analysts remain optimistic. A January 2026 report noted that Kalshi's weekly trading volume surged to $2.3 billion in early January 2026, driven by sports events like college football and NFL playoffs. Polymarket, meanwhile, expanded into earnings-based prediction markets via a partnership with Stocktwits. These developments suggest that demand for event-based derivatives is robust, even as legal risks persist.

Investor Sentiment and Regulatory Projections

Investor confidence in prediction markets remains high, but not without caution. A December 2025 Bloomberg article highlighted that Kalshi's valuation doubled to $11 billion in 2025, while Polymarket's $2 billion funding round signaled institutional buy-in. However, regulatory uncertainty remains a key risk. A January 2026 analysis noted that prediction markets could cannibalize $8 billion in annualized sports betting handle, prompting traditional operators like DraftKings and FanDuel to enter the space. This competition could dilute margins for early entrants like Kalshi and Polymarket.

The legal landscape is also evolving. The CFTC has signaled a more accommodating stance, acknowledging the need to modernize its approach to prediction markets. Yet, the absence of a Supreme Court ruling on federal preemption means the regulatory framework remains fragmented. A potential circuit split-evident in rulings from the Fourth, Third, and Ninth Circuits-increases the likelihood of a Supreme Court review. Until clarity emerges, investors face a dual risk: regulatory crackdowns in states like New York and Nevada, and the possibility of a federal ruling that could either legitimize or dismantle the industry.

Implications for Investors

For investors, the key variables are regulatory outcomes and market adoption. If federal courts uphold the CFTC's authority, prediction markets could become a mainstream financial asset, with Kalshi and Polymarket positioned as industry leaders. Conversely, a ruling favoring state and tribal regulators could trigger a wave of cease-and-desist orders, fines, and operational restrictions.

The ORACLE Act and similar state legislation also present opportunities and risks. While they could impose costly compliance burdens, they might also create a path for regulated growth. For example, New York's proposed framework includes consumer protections like self-exclusion mechanisms and deposit limits, which could set a template for other states. Investors must weigh these possibilities against the platforms' current growth trajectories.

In the short term, Kalshi's CFTC registration and Polymarket's CFTC-regulated exchange provide a buffer against state-level enforcement. However, the long-term viability of these platforms depends on resolving the federal-state conflict. As one Kalshi representative put it, "Prediction markets are not just a niche product-they're the next frontier of financial innovation." Whether that frontier is navigable will depend on the courts and Congress.

Conclusion

The legal and regulatory battle over prediction markets is far from settled. While Kalshi and Polymarket have demonstrated resilience in the face of enforcement actions, their long-term success hinges on achieving regulatory clarity. For investors, the stakes are high: a favorable federal ruling could unlock a trillion-dollar market, while a fragmented regulatory landscape could stifle growth. As the industry moves into 2026, the path forward will require both legal acumen and strategic adaptability.