The Regulatory Risks and Opportunities in Prediction Markets as States Crack Down on Unlicensed Wagering

The prediction market sector, once a niche corner of financial innovation, has exploded into a $40–50 billion annualized trading volume juggernaut by late 2025. Platforms like Kalshi, Polymarket, and Crypto.com have capitalized on this surge, leveraging event-based contracts tied to sports, politics, and global events. However, this rapid growth has collided with a fragmented regulatory landscape, where state-level enforcement actions are increasingly challenging the legal and financial viability of these platforms. As states like Tennessee, Nevada, and Maryland crack down on unlicensed wagering, the sector faces a critical inflection point: Will regulatory clarity foster innovation, or will compliance burdens stifle its potential?

State-Level Enforcement: A New Frontier of Legal Uncertainty

The regulatory battleground has shifted decisively to the states. In January 2026, Tennessee's Sports Wagering Council issued cease-and-desist orders to Kalshi, Polymarket, and Crypto.com, demanding they halt sports betting contracts for state residents and refund deposits by January 31. Tennessee regulators argued that these platforms, despite CFTC registration, violated state laws by operating unlicensed gambling operations. This action mirrored similar moves in Nevada and Maryland, where courts have questioned whether sports-related event contracts fall under federal derivatives law or state gaming statutes.

The Nevada case, in particular, has been a watershed moment. In November 2025, a federal court ruled that sports event contracts are not federally protected swaps under the Commodity Exchange Act, effectively classifying them as gambling. This decision emboldened states to assert jurisdiction, with Kalshi and Crypto.com forced to suspend operations in Nevada. Meanwhile, Maryland's courts denied Kalshi's motion for a preliminary injunction, citing insufficient evidence of federal preemption. These rulings create a patchwork of conflicting legal standards, complicating compliance for platforms operating across state lines.

Compliance Costs and Financial Impacts: A Double-Edged Sword

The legal uncertainty has translated into tangible financial pressures. Kalshi, which secured CFTC registration as a Designated Contract Market (DCM), has faced mounting litigation costs, with cease-and-desist orders from New York, Nevada, and Tennessee. While the platform reported $2.3 billion in weekly trading volume in December 2025, its compliance expenses have surged due to anti-money laundering (AML) and know-your-customer (KYC) requirements. Polymarket, which restructured under a licensed derivatives exchange (QCX) to secure a CFTC no-action letter, has also incurred costs to align with state-specific regulations.

The financial stakes extend beyond legal fees. States are now eyeing prediction markets as a new revenue stream. Illinois, for instance, imposes a 50% tax burden on sports betting operators, and regulators warn similar measures could apply to prediction markets. Tennessee's cease-and-desist orders, which mandate refunds and contract voiding, could force platforms to forgo revenue in key markets. For Crypto.com, which pulled its prediction market product from several states due to legal risks, the revenue loss is compounded by reputational damage.

User Growth and Market Dynamics: Resilience Amidst Turbulence

Despite regulatory headwinds, user growth remains robust. Kalshi's valuation soared to $11 billion in late 2025 after a $1 billion Series E funding round, driven by partnerships with media giants like CNN and the NHL's Chicago Blackhawks. Polymarket, backed by Intercontinental Exchange (ICE) and Paradigm, reported $3.6 billion wagered on a single 2024 election question, while its monthly active traders approached 462,600. However, profitability remains skewed: On Polymarket, 70% of its 1.7 million trading addresses recorded losses, with the top 0.04% capturing $3.7 billion in realized gains.

This concentration of profits raises questions about market accessibility and retail investor risk. Meanwhile, platforms are adapting by narrowing their offerings to non-gambling legal definitions. For example, Kalshi and Polymarket adjusted their 2026 FIFA World Cup event contracts to align with regulatory requirements. Such agility underscores their potential to navigate evolving rules, but also highlights the fragility of their business models in the face of state-level enforcement.

The Path Forward: Balancing Innovation and Compliance

The long-term viability of prediction markets hinges on resolving the federal-state regulatory divide. While the CFTC has signaled openness to modernizing derivatives frameworks, state actions suggest a preference for treating these markets as gambling. A Supreme Court ruling on federal preemption could clarify jurisdictional boundaries, but until then, platforms must prepare for a fragmented landscape.

For investors, the sector presents both risks and opportunities. Kalshi's $40–50 billion valuation and Polymarket's institutional backing suggest strong fundamentals, but compliance costs and state tax burdens could erode margins. Conversely, regulatory clarity-whether through federal preemption or state licensing-could unlock mainstream adoption, particularly as prediction markets gain traction in media and financial forecasting.

Conclusion

Prediction markets stand at a crossroads. The Tennessee, Nevada, and Maryland cases illustrate the escalating regulatory risks, but they also highlight the sector's disruptive potential. For platforms like Kalshi, Polymarket, and Crypto.com, the challenge lies in balancing innovation with compliance. Investors must weigh the likelihood of regulatory harmonization against the immediate costs of enforcement actions. In this high-stakes environment, the winners will be those who can navigate the legal maze while maintaining the agility to capitalize on a market that, despite its turbulence, continues to redefine the boundaries of financial innovation.