The Legal and Regulatory Risks Facing Prediction Markets and Their Impact on Crypto Investments

The rise of prediction markets has ignited a regulatory firestorm, with state-level enforcement actions increasingly threatening the viability and scalability of platforms like Kalshi, Polymarket, and Robinhood. As these platforms navigate a fragmented legal landscape, their struggles underscore broader risks for crypto investments, where regulatory uncertainty continues to shape market dynamics and investor behavior.

A Surge in State-Level Enforcement

Since 2023, state regulators have escalated their scrutiny of prediction markets, framing them as unregulated gambling activities rather than financial derivatives. Nevada became a trailblazer in this effort, issuing a cease-and-desist order to Kalshi in 2025, arguing that its sports-related event contracts circumvented state gaming laws according to reports. Kalshi's counterargument-that it operates under federal CFTC oversight-sparked a legal battle that set a precedent for subsequent actions. By 2026, over 20 enforcement actions and lawsuits had been initiated by states and tribal nations, with New Jersey, Maryland, and New York joining the fray. Massachusetts' lawsuit against Kalshi, which highlighted that 75% of its trading volume in 2025 was on sports outcomes, marked a strategic shift toward state court litigation to bypass federal jurisdiction according to industry analysis.

The regulatory onslaught has not been limited to legal threats. Pennsylvania and Illinois, among others, have introduced licensing and AML requirements for crypto exchanges, while Florida and Missouri updated KYC laws to include cryptocurrency-specific provisions as state regulators have expanded. These measures signal a broader trend of states asserting control over digital assets, even as industry players push for federal preemption.

Legal and Legislative Battles: Gambling vs. Derivatives

At the heart of the conflict lies a fundamental disagreement over classification. State regulators argue that prediction markets, particularly those tied to sports or political events, function as unregulated gambling platforms, falling under their jurisdiction according to legal analysis. Conversely, companies like Kalshi and Coinbase contend that these markets are financial derivatives, subject to federal oversight by the CFTC as industry sources note. This dichotomy has led to conflicting court rulings, with a Nevada federal judge ruling in 2025 that sports-related event contracts are not swaps and thus outside CFTC jurisdiction according to court documents. Such ambiguity has created a patchwork of regulations, complicating compliance and scalability for operators.

Legislative efforts have further muddied the waters. New York's ORACLE Act (Assembly Bill 9251), introduced in November 2025, proposed a structured framework for prediction markets, including age restrictions and prohibitions on sports and political markets as proposed legislation. Meanwhile, Pennsylvania's informational hearings highlighted concerns about consumer protection and revenue generation, drawing parallels between prediction markets and traditional sports wagering according to state reports. These divergent approaches reflect a lack of consensus at the state level, increasing operational risks for platforms seeking to expand.

Impact on Crypto Investments and Industry Reactions

The regulatory uncertainty surrounding prediction markets has had spillover effects on broader crypto investments. According to a report by ScienceDirect, SEC actions in 2025 triggered sharp declines in crypto asset returns, with some assets dropping by 17.2% in the 30 days following enforcement announcements according to research findings. This volatility has prompted investors to adopt more cautious strategies, favoring jurisdictions with clearer regulatory frameworks.

State-level enforcement has also accelerated industry adaptations. Kalshi and Polymarket, for instance, secured significant funding in 2025, with Kalshi reaching a $11 billion valuation and Polymarket partnering with major sports leagues and news organizations to legitimize its offerings as industry reports indicate. However, these efforts have not insulated the sector from legal risks. Polymarket faced a CFTC enforcement action requiring it to restrict U.S. access to certain markets, while PredictIt's reliance on a 2014 no-action letter left it vulnerable when the CFTC withdrew its exemption according to legal analysis.

At the federal level, the Trump administration's January 2025 executive order on digital assets signaled a shift toward regulatory clarity, establishing the President's Working Group on Digital Asset Markets and rescinding SAB 121 to enable banks to offer crypto custody services as executive action details. Despite these efforts, challenges persist. The SEC's Crypto Task Force, led by Commissioner Hester Peirce, has emphasized structured compliance pathways, but enforcement actions against exchanges like OKX highlight ongoing risks according to regulatory reports.

The Road Ahead: Risks and Opportunities

The future of prediction markets-and their impact on crypto investments-hinges on resolving jurisdictional conflicts. With over 20 lawsuits pending and potential Supreme Court intervention, the sector faces a pivotal moment. Experts predict industry consolidation in 2026, as only a few platforms with robust compliance frameworks survive according to market analysis. For investors, this means heightened exposure to regulatory outcomes, with the potential for either market legitimization or collapse.

Meanwhile, the tokenization of real-world assets and institutional adoption of stablecoins under frameworks like the EU's MiCA and the U.S. GENIUS Act offer alternative avenues for growth as policy analysis shows. These developments suggest that while prediction markets remain contentious, the broader crypto ecosystem is evolving toward structured innovation.

Conclusion

State-level enforcement actions against prediction markets have exposed significant legal and regulatory risks, threatening their scalability and viability. As platforms grapple with conflicting state laws and federal jurisdictional debates, the sector's future remains uncertain. For crypto investors, the lesson is clear: regulatory clarity is as critical as technological innovation. Those who navigate this landscape with caution-and a keen eye on evolving legal precedents-may yet find opportunities in a market poised for transformation.