A goat herder in Northern California just did something more typical of a Wall Street investment bank – hedge risk with derivatives. Tim Arrowsmith’s labor costs were about to more than triple after a state wage exemption policy expired on June 30. No insurer would cover that risk. No futures contract existed for it. So he paid $50,000 for a contract on Kalshi that pays him $500,000 if Sacramento doesn’t fix the rule by October 1. Now, if Sacramento does fix it, his labor costs stay the same and he’s only lost $50,000. If they don’t, he’ll have $500,000 to cover the increased labor costs.
Because of prediction markets, for the first time ever, small businesses like Arrowsmith’s have access to risk management tools that Wall Street has used for years.
Until more recently, most Americans didn’t think about derivatives markets, but those markets and instruments have let farmers, oil producers, financial conglomerates, and entire sectors of the economy keep prices and costs more stable by transferring risk to someone willing to carry it. They also broadcast valuable information about where risk is headed to better inform decision-making. US derivatives markets have helped create and sustain the greatest economy on earth.
The primary reason is that the design of the Commodity Exchange Act (CEA), the law that governs those markets, has led to the most innovative and broad set of derivative instruments in the world, traded on the most well-regulated markets anywhere. The CEA recognizes that anything that can pose risk to people and businesses, whether it be a physical good, a financial concept, or an actual event, is a valid underlier for a derivative listed on a federally regulated marketplace.
While prediction markets’ explosive growth is a recent phenomenon, event contracts aren’t new and are just another prior innovation within that framework, not a departure from it. On a prediction market, event contracts pay out based on whether or not something happens in the real world: who will win an election or the World Cup, whether or not there will be a recession, how many cars Tesla will deliver every quarter, and more.
What is also not new is hearing comparisons of financial trading activity to gambling. As long as markets have existed, so have their critics who only view markets as providing an opportunity for “risky bets”. Yet trading on federally regulated derivatives markets is quite distinct from gambling on roulette in a Las Vegas casino or letting DraftKings set your odds, limit your wins, and profit from your losses. It is the venue, not specifically the product, that determines the appropriate regulatory treatment and characterization of the activity.
Prediction markets, unlike a bookie who takes the other side of your bet and sets the odds, are financial exchanges. They act as intermediaries and do not favor one side of the trade. The market – not the exchange – sets the prices and traders can exit their position at any time, as they do in a traditional financial market. While some products may seem like they overlap between both worlds, it’s what’s behind the screen that matters. That hasn’t stopped Casinos and sportsbooks, who have every reason to feel threatened by a more fair and transparent model, from insisting these markets have no economic utility. They should speak for themselves.
The Arrowsmith hedge is just one example of what prediction markets are making possible. Event contracts now cover risks that no risk-management product previously reached: environmental funds hedging California carbon allowance prices, ice cream shops hedging a rainy summer. Businesses too small to interest a Wall Street desk can transfer a specific risk to someone willing to price it.
Beyond the ability to actually trade the markets, much more value lies in the information they provide. Unlike social media posts, which optimize for attention and “what you want to be true,” prediction markets optimize for accuracy and “what will be true.” A recent Federal Reserve report found that Kalshi markets give an accurate, real-time read on the economy valuable to both researchers and policymakers, even beating Fed funds futures at predicting interest-rate moves.
Yet, just because of the sports link, many states have now allied with casino interests to try to ban prediction markets and apply piecemeal state-level regulation meant for roulette wheels to instruments designed for price discovery and risk management. States, driven by gaming interests, have sued prediction markets because they’re worried about competition. New York, the capital of finance, is one of them.
Beyond the absurdity of using a regulatory model which addresses the inherent conflict presented by casino businesses – house-set odds designed to ensure the house wins and profiting directly off customer loses – national markets need uniform, federal, and exchange-focused rules to work.
Imagine if a state could prevent you from buying Tesla stock because its governor didn’t like Elon Musk. Or, if you could only buy a stock on the New York Stock Exchange from other traders in your own state. The stock exchange as we know it would cease to exist.
As a former CFTC commissioner, I’ve seen how valuable derivatives are to farmers, oil producers, and financial institutions to insure against the risks of doing business. What these markets also produce is a price for things nobody else will price, which is worth something at a moment when trust in most other sources of information is falling. Both of those functions are what the law that governs derivatives, and its federal regulator, are meant to protect.
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