Regulatory Roundup: From Elections to Sports—The Dynamics of Decentralized Prediction Markets

Analysis

From Elections to Sports—The Dynamics of Decentralized Prediction Markets

Exploring the unfamiliar often sheds new light on the familiar. This month, we explore the world of decentralized prediction markets, highlighting a recent case of potential manipulation. These markets saw a remarkable surge last year, fueled by bets on the U.S. presidential election. A report revealed a staggering 565% increase in Q3 2024, with the top three venues amassing $3.1 billion. By merging traditional prediction markets with DeFi concepts, decentralized prediction markets create a unique marketplace.

Key Takeaways

• Decentralized prediction markets blend traditional prediction markets with DeFi concepts and experienced a significant boost from betting on the U.S. presidential election.
• The legal landscape surrounding prediction markets is complex, with recent developments, notable cases and an evolving stance in the U.S.
• Active monitoring and transparent contract resolution are essential in prediction markets, highlighted by recent manipulation incidents and fairness measures.

How Decentralized Prediction Markets Work: Trading Contracts and Setting Odds 

The most common types of prediction markets trade contracts representing a future event, with shares priced between $0.00 and $1.00, reflecting a 0% to 100% chance of the event occurring. Predictions can range from serious topics like “Who will be the next Prime Minister of Australia?” to the more fanciful “Will the FBI announce a partnership with the UFC to train its agents before July?” The price of the contract indicates the odds of the event happening and fluctuates as participants buy or sell based on their expectations. For instance, if the price of a contract is $0.15 and you believe the chance of the UFC training FBI agents is significantly lower than 15%, you might place a bid in at $0.05. However, this requires someone to take the opposite side. This highlights the key aspect of prediction markets: they are two-sided. You are trading not with the house, but with other traders, and the odds are determined by supply and demand.

Another key differentiator of prediction markets is their flexibility; you aren’t locked into your position. As time progresses and new information emerges, you can sell your position. The price (odds) will fluctuate until the event outcome is determined. When the outcome event occurs, the contract will resolve to either 0% or 100%, paying out at either $0 or $1 respectively. Extensive academic research has shown prediction markets often yield better results than traditional methods. The University of Iowa has operated their own prediction market, the Iowa Electronic Market (IEM), since 1988, and it is renowned for its political markets.

Legal Challenges in Prediction Markets: Recent Developments and Future Outlook

The legal landscape surrounding prediction markets is complex, with bans in many jurisdictions for certain types of sensitive contracts.

For example, betting on elections is banned in Taiwan, where 17 people were arrested for using a prediction market on the Taiwan election. Similarly, predictions on sporting events often clash with sports betting regulations, which vary significantly from country to country. In the U.S., the stance has historically been averse to prediction markets, with notable exceptions like the IEM, which has been operating under a no-action-letter from the CFTC.

In 2022, the CFTC banned the largest platform, Polymarket, stating that the contracts, “each of which is composed of a pair of binary options, constitute swaps under the CFTC’s jurisdiction, and therefore can only be offered on a registered exchange in accordance with the CEA and CFTC regulations.” However, more recently, things have been changing. KalshiEx won a case in October 2024, allowing them to continue trading event contracts, with other platforms soon indicating their own prediction market offerings in the works. While it’s not a total green light, it’s clear we’ll see more activity from prediction markets in the U.S. in 2025.

The DeFi Revolution in Decentralized Prediction Markets

Prediction markets are evolving with the incorporation of DeFi, and Polymarket is a prime example, utilizing DeFi in two ways—all activity is conducted in USDC, a U.S. dollar-linked stablecoin, and all market resolutions are decentralized. The resolution of the outcome is critical in prediction markets. Clear outcomes within fixed times are crucial, e.g., “Who will be the next Prime Minister of Australia after the election?” is a workable prediction, whereas “Who will be the most popular Prime Minister?” is open to dispute. Even the best-designed predictions can face disputes, making outcome and dispute resolution crucial components of prediction market design, but still prone to manipulation.

In Polymarket and other prediction markets, resolutions and disputes are handled through the UMA Optimistic Oracle, a decentralized data recording and verification platform. Here's how it works: A user proposes a resolution and posts a bond. It sits in the UMA Oracle for a challenge period. If unchallenged, it's considered verified; if challenged, UMA token holders vote. The process operates through a series of incentive schemes; for example, if the resolution is rejected, the user loses their bond. Successful challengers receive half of the bond, and voters are rewarded for consistently voting correctly.

Nevertheless, no system is airtight. Earlier this year, a contract was created titled “Ukraine agrees to Trump mineral deal before April?” As of late April, only a memorandum of intent was being put in place, with no deal agreed upon before March 31. Despite disputes within the UMA Oracle, the contract resolution was marked "Yes," resulting in a full payout for incorrect predictions and leaving accurate predictors empty-handed.

It's unclear how this happened, but there are a few possibilities. One is that a “whale,” someone who controls many UMA tokens, cast a significant number of votes to influence the outcome for profit. Alternatively, the challenge may have been ignored by the UMA community due to limited oversight on the voting group's composition. Polymarket has not provided many details on the incident, apart from stating that they plan to develop new monitoring systems.

Lessons Learned: Ensuring Integrity in Prediction Markets

It’s unlikely that this incident will dampen the growing popularity of prediction markets, but there are important lessons to be learned. Firstly, active monitoring is essential. It enables organizations to quickly detect and diagnose incidents, allowing for decisive and transparent responses. Secondly, this incident highlights the crucial nature of the contract resolution process and its potential as a risk area for fraud or market failure.

April 2025 Capital Markets Regulatory Updates

17 April: The Canadian Securities Administrators (CSA) published amendments to National Instrument 81-102 to provide regulatory clarity for Public Crypto Asset Funds, including criteria for crypto assets, investment restrictions, and custody requirements.

14 April: The South Korean Financial Intelligence Unit (FIU) requested Apple to restrict access to 14 crypto apps, which aims to curb unregistered foreign virtual asset services. 

14 April: The South Korean Financial Services Commission (FSC) announced that the government approved the revision bill for the Enforcement Decree of the Financial Investment Services and Capital Markets Act (FSCMA) intended to establish new sanctions mechanisms against unfair trading and illegal short sale activities. The revised Enforcement Decree is scheduled to go into effect on April 23, 2025. 

13 April: The Thai Securities and Exchange Commission (SEC) will coordinate with relevant agencies to quickly enforce new restrictions on foreign digital asset platforms soliciting or advertising to Thai investors, following the implementation of recent emergency decrees on digital assets and cybercrime. 

10 April: The European Securities and Markets Authority (ESMA) finalized rules on firms’ order execution policies under MiFID II. The final report outlines rules for investment firms to establish and assess their order execution policies, aiming to enhance order execution and investor protection.

10 April: The Bank of England published the Prudential Regulation Authority (PRA) Business Plan 2025/26, focusing on banking and insurance sector safety, emerging risks, market competitiveness, and efficient regulation.

10 April: The Canadian Investment Regulatory Organization (CIRO) published its Annual Priorities for 2026, focusing on integration, regulatory delivery, and advancing its strategic plan to enhance efficient regulation, investor protection, and industry evolution. 

9 April: The Senate confirmed the nomination of Paul Atkins as Chair of the SEC. Chair Atkins was approved to serve for the remainder of Gary Gensler’s term, which expires June 5th, 2026. 

8 April: The U.K. Financial Conduct Authority (FCA) published its strategic priorities for 2025/2026, which include becoming a smarter regulator, supporting growth, helping consumers navigate their financial lives, and fighting financial crime through enhanced data-led detection and collaboration.

8 April: The U.S. Department of Justice (DOJ) disbanded its National Cryptocurrency Enforcement Team and refocusing crypto investigations on drug cartels and terrorist groups, while easing regulations on virtual currency exchanges and related services. 

7 April: The Hong Kong Securities and Futures Commission (SFC) issued guidance for licensed virtual asset trading platforms and SFC-authorized funds on staking services, emphasizing security, risk management, and expanding regulated offerings in Hong Kong's virtual asset ecosystem. 

4 April: The U.S. Securities and Exchange Commission (SEC)'s Division of Corporation Finance issued a statement clarifying that certain stablecoins designed to maintain a one-for-one value with USD and backed by low-risk assets do not constitute securities under federal law.

2 April: The International Organization of Securities Commissions (IOSCO) released its final report on “Standards Implementation Monitoring (ISIM) for Principles (6-7) Relating to the Regulator.” The report found high implementation levels across 55 jurisdictions, highlighting good practices and areas for improvement in managing systemic risk and reviewing the perimeter of regulation.

26 March: The House Financial Services Committee voted to advance stablecoin legislation, approving the STABLE Act. The bill will provide a framework for dollar-denominated stablecoins, including reserve requirements and anti-money laundering standards.