The Rising Risks of Prediction Markets and Their Implications for Retail Investors

The prediction market sector, once a niche experiment in financial innovation, has surged in popularity by 2025, drawing millions of retail investors with its promise of democratizing speculative trading. However, this growth has exposed a critical flaw: the absence of robust regulatory guardrails. As platforms like Polymarket and Kalshi navigate legal gray areas, retail investors face mounting risks—from fraud and manipulation to a lack of consumer protections. The urgency for a coherent regulatory framework has never been clearer.

A Patchwork of Regulations: Global Disparities and Loopholes

The regulatory landscape for prediction markets remains fragmented. In the United States, the Commodity Futures Trading Commission (CFTC) has taken a cautious approach. While the CFTC’s recent no-action letter to Polymarket—allowing its U.S. subsidiary to operate under structured compliance—signals a shift toward innovation-friendly oversight, it also highlights the agency’s limited capacity to address systemic risks [3]. Meanwhile, the dismissal of the CFTC’s appeal against Kalshi in May 2025 removed a key barrier for new entrants but left unresolved questions about how to define and regulate event contracts [4].

In the European Union, the Markets in Crypto-Assets (MiCA) regulation, implemented in early 2025, provides a harmonized framework for cryptoassets but does not explicitly cover prediction markets [2]. This omission creates a regulatory vacuum, as digital assets increasingly underpin speculative trading platforms. The UK’s Digital Markets, Competition and Consumers Act (DMCC Act) has similarly focused on merger control and digital market fairness, leaving prediction markets in a legal limbo [1].

Singapore, however, has adopted a hardline stance. The Gambling Regulatory Authority (GRA) banned Polymarket in 2025 under the Gambling Control Act 2022, blocking user access and imposing fines of up to $10,000 for violations [1]. This crackdown reflects a broader trend in Asia, where regulators prioritize consumer protection over innovation, often at the expense of market dynamism.

Retail Investors: Trapped in a High-Risk Ecosystem

Retail investors are particularly vulnerable in this unregulated environment. Social media-fueled manipulation has become a pervasive threat. Coordinated campaigns using bots, synthetic amplification, and burner accounts distort public perception, creating artificial demand for speculative assets [5]. For example, the infamous GameStop short squeeze in 2021 demonstrated how retail investors could be swayed by unverified information on platforms like Reddit, leading to volatile market movements and significant losses for short sellers—and often, retail participants [5].

Insider trading and information asymmetry further exacerbate risks. Studies reveal that insiders frequently exploit confidential knowledge to trade in connected markets, distorting signals for retail investors [1]. Additionally, financial literacy gaps leave many retirees and less-educated investors susceptible to pump-and-dump schemes and misleading promotions [3].

The rise of crypto-based prediction markets introduces additional layers of risk. Liquidity crises, cyberattacks, and regulatory uncertainty have already destabilized the broader crypto sector, as seen in the collapses of FTX and Terra/Luna [1]. These events underscore the need for stringent safeguards to prevent similar failures in prediction markets.

The Urgent Need for Guardrails

Regulators must act swiftly to close these gaps. The CFTC’s recent roundtable on prediction markets—focusing on retail fraud, customer protection, and regulatory revisions—is a step in the right direction [1]. However, as outgoing CFTC Commissioner Kristin Johnson warned, the sector’s rapid growth has outpaced the development of guardrails, enabling firms to exploit loopholes [1].

In the U.S., a clear definition of event contracts and their regulatory classification is essential. The SEC’s Q2 2025 enforcement actions against crypto fraud and social media manipulation schemes demonstrate the agency’s commitment to investor protection [3]. Yet, real-time detection of AI-driven manipulation remains a challenge, requiring collaboration with tech firms and social media platforms.

The EU could leverage MiCA’s framework to extend oversight to prediction markets, ensuring licensing requirements and consumer protections mirror those for cryptoassets. Meanwhile, Singapore’s strict approach, while effective in curbing unregulated gambling, risks stifling innovation. A balanced model—combining consumer safeguards with innovation incentives—would better serve both investors and markets.

Conclusion: Innovation vs. Protection—Striking the Right Balance

Prediction markets represent a frontier of financial innovation, but their risks demand urgent regulatory attention. Retail investors, often the most vulnerable, need clear boundaries, transparent rules, and enforceable protections. As the CFTC and global regulators grapple with this challenge, the sector’s future hinges on a delicate balance: fostering innovation while ensuring that the next generation of markets does not repeat the failures of the past.

Source:
[1] CFTC Grants Polymarket Green Light for US Return [https://m.fastbull.com/news-detail/cftc-grants-polymarket-green-light-for-us-return-4342366_0]
[2] UK FCA maintains crypto benchmark framework after EU ... [https://www.cfbenchmarks.com/blog/cf-benchmarks-offers-unique-regulatory-status-and-global-reach-after-eu-decision-threatens-availability-of-regulated-crypto-indices-2]
[3] SEC Enforcement Activity in the Second Quarter of 2025 [https://www.swlaw.com/publication/sec-enforcement-activity-in-the-second-quarter-of-2025-the-start-of-the-back-to-basics-atkins-era/]
[4] Are Prediction Markets a Smart Trading Strategy or Just ... [https://www.investopedia.com/are-prediction-markets-gambling-11769489]
[5] Social Media-Fueled Investment Fraud: Exploring the Dark Side of Public Perception Manipulation [https://blackbird.ai/blog/social-media-fueled-investment-fraud-exploring-the-dark-side-of-public-perception-manipulation/]