The Tax Uncertainty in Prediction Markets: A Risk and Opportunity for Early-Stage Investors

The rise of prediction markets has introduced a novel asset class that sits at the intersection of finance, technology, and regulation. These markets, which allow participants to bet on the outcomes of events ranging from political elections to economic indicators, have grown rapidly since 2024, spurred by a landmark legal victory for KalshiEX LLC against the U.S. Commodity Futures Trading Commission (CFTC). This ruling enabled the classification of prediction contracts as federally regulated derivatives, unlocking a surge in trading volumes-over $27.9 billion in contracts traded between January and October 2025 according to financial analysis. Yet, as these markets expand, they face a critical challenge: tax uncertainty. For early-stage investors, this ambiguity presents both risks and opportunities, depending on jurisdiction and regulatory alignment.

The U.S. Model: Favorable Tax Treatment and Regulatory Clarity

In the United States, prediction markets have benefited from a unique regulatory framework. The CFTC's 2024 decision to classify event contracts as derivatives under federal law allowed platforms like Kalshi and Polymarket to operate legally in all 50 states. This classification also conferred significant tax advantages. Unlike traditional gambling, where winnings are taxed as ordinary income and losses are deductible only up to gains, prediction market contracts are often treated as Section 1256 contracts under the Internal Revenue Code. This allows traders to apply the 60/40 rule, splitting gains and losses into 60% long-term capital gains and 40% short-term capital gains, resulting in lower effective tax rates.

However, this favorable treatment is not without risks. The CFTC's oversight introduces complexity, particularly around whether these contracts might eventually be reclassified as wagers under federal excise tax provisions according to industry analysis. Moreover, the 2026 implementation of the "One Big Beautiful Bill Act" will further tilt the playing field. Under this law, gamblers will no longer be able to deduct losses from winnings, effectively taxing gross gains at higher rates according to tax experts. This shift is expected to drive speculative activity toward prediction markets, which retain their Section 1256 status. For investors, this creates a short-term opportunity: capitalizing on a growing user base while the tax advantages remain intact.

International Ambiguity: A Double-Edged Sword

Outside the U.S., the regulatory and tax landscape for prediction markets remains murky. In Singapore and Japan, for instance, there is no explicit guidance on how these contracts would be taxed. Both countries have implemented the OECD's Pillar Two global minimum tax (15%) for multinational enterprises with revenues exceeding €750 million, effective from 2025-rules-and-domestic-top-up-tax-(dtt)). While this reform targets corporate tax avoidance, it does not address the classification of prediction markets. In Japan, however, a 2026 overhaul of digital asset regulations may offer indirect insights. The country plans to reclassify cryptocurrencies as financial products under the Financial Instruments and Exchange Act, subjecting them to a flat 20% tax rate and stricter disclosures. If prediction markets are similarly categorized as derivatives, they could inherit comparable tax treatment.

The European Union, meanwhile, is simplifying tax reporting requirements but has not yet issued specific rules for prediction markets. The EU's Competitiveness Compass initiative emphasizes reducing regulatory burdens and promoting cross-border investment. While this suggests a potential openness to innovation, the absence of clear guidelines leaves investors exposed to sudden regulatory shifts. For example, if the EU were to classify prediction markets as gambling products, they would face higher tax rates and stricter licensing requirements, akin to traditional sports betting.

Risk vs. Opportunity: Navigating the Uncertainty

For early-stage investors, the key lies in balancing the U.S. market's relative clarity with the untapped potential of international jurisdictions. The U.S. offers a proven model where tax advantages and regulatory legitimacy have driven rapid growth. Platforms like Crypto.com | Derivatives North America (CDNA), a CFTC-regulated entity, have leveraged this framework to attract institutional capital and provide tax-efficient trading environments. However, the risk of future regulatory reclassification-whether by the CFTC or Congress-remains a wildcard.

Conversely, international markets present a high-reward, high-risk proposition. While Singapore and Japan lack specific tax rules for prediction markets, their broader financial frameworks suggest a potential for favorable treatment if these contracts are classified as derivatives. Investors willing to navigate regulatory ambiguity could gain first-mover advantages in regions where demand for speculative instruments is rising. The challenge, however, is significant: cross-border compliance costs, divergent tax regimes, and the possibility of retroactive regulatory changes could erode returns.

Conclusion: A Strategic Imperative for Investors

Prediction markets are reshaping the financial landscape, but their long-term viability hinges on resolving tax and regulatory uncertainties. For U.S. investors, the current environment offers a unique window to capitalize on favorable tax rules and a growing user base. For those with a global outlook, the lack of clarity in jurisdictions like Singapore and Japan represents both a risk and an opportunity. As the OECD's Pillar Two reforms and national regulatory agendas evolve, early-stage investors must remain agile, hedging against potential tax reclassifications while positioning themselves to benefit from the inevitable expansion of this asset class.

In the end, the tax uncertainty surrounding prediction markets is not a barrier but a catalyst. It forces investors to think critically about regulatory trends, jurisdictional advantages, and the interplay between innovation and compliance. For those who navigate this terrain with foresight, the rewards could be substantial.