Crypto isn’t the only emerging issue on the CFTC’s plate. The futures regulator is also weighing a fintech sector that has similarly tricky political implications: election bets.
The Commodity Futures Trading Commission has set Oct. 28 as a date by which it hopes to decide whether the New York-based startup Kalshi can offer a form of wagering up to $25,000 on which party will control the House of Representatives and Senate after the midterms. PredictIt, another online market for election trading, has also sued the regulator over its decision to cancel a no-action letter.
The recently closed public comment period on Kalshi’s proposal brought letters from a range of big names in tech, finance, and academia, debating how so-called prediction markets could affect elections, for better or worse.
Gambling on elections in the U.S. is generally outlawed — though it wasn’t always that way and is allowed in other countries, including the U.K. Kalshi describes its proposal not as Las Vegas-style gambling but as a prediction market where users buy and sell contracts on events based on their perceived probability.
Kalshi in late 2020 registered with the CFTC as a designated contract market, describing itself as the first regulated events-focused futures market. On its service, users can trade contracts on everything from the size of the Fed’s next rate hike to the high temperature in Chicago to the next Moon landing. Contracts pay out $1 if the underlying event occurs as predicted and are priced to correlate with that perceived likelihood, so a 40 cent price could be read as a 40% chance.
A few months after getting the nod from regulators, the company raised $30 million from a list of investors that included Sequoia Capital, Charles Schwab (the chairman of the financial services company), and Henry Kravis of KKR. The mix of Silicon Valley money and traditional finance speaks to Kalshi’s broad ambitions.
“We want to build an ecosystem that can rival the New York Stock Exchange or CME down the line,” CEO and co-founder Tarek Mansour told Protocol.
That ecosystem has not included election-focused markets to this point. But in July, Kalshi asked for permission to change that and launch two events contracts on the outcome of this fall’s midterms. Such contracts, Mansour said, can help people hedge against election risk and paint a more accurate picture of the race.
The CFTC has in the past denied similar applications, ruling that election prediction markets are gaming and do not serve the public interest. It has also taken action against international companies that allow Americans access to election trading. It has only allowed election contract trading on a smaller scale through limited approvals for PredictIt and Iowa Electronic Markets, which are both affiliated with universities.
Reducing risk or creating it?
Kalshi has a mix of tech industry heavyweights and academics backing its regulatory proposal.
Former top Obama economic adviser and Harvard professor Jason Furman wrote in to note that the White House regularly used prediction markets to understand the potential real-world impact of decisions.
“Elections are not games, and the outcome of political control of Congress has enormous public interest ramifications,” Furman said. “Election-focused prediction markets combine the economic significance of a powerful risk reduction tool for small businesses with the social significance of a powerful forecasting tool for researchers and policymakers.”
Elections are not games, and the outcome of political control of Congress has enormous public interest ramifications”
Dustin Moskovitz, the Facebook and Asana co-founder, wrote that the $25,000 bets allowed by Kalshi would be too small to have any influence over the “multi-billion dollar affairs” that are U.S. elections. (He’s been a major Democratic donor himself.) But the prediction market could, in his view, help people better understand elections.
“Rather than listen to pundits with a less-than-ideal track record and perceived partisan biases, the broader public can be informed by the unbiased market,” he wrote.
Reviving old concerns
But many of the same concerns remain a decade after the last proposal, from Nadex, was declined by the CFTC in 2012.
“When we think about what happened in 2020, do we really want another excuse for the American people to question the integrity of our elections?” former CFTC Commissioner Jill Sommers told POLITICO.
Dennis Kelleher, chief executive of the nonprofit Better Markets, said in an interview that the important role of commodity markets is “getting lost in the discussion” of the proposal. He wrote out a detailed argument against the proposal in a letter to the CFTC.
“The futures markets were not established as a new type of casino but to facilitate the provision of essential goods to Americans by enabling commercial entities to manage the price risk associated with their productive commercial activities,” Kelleher wrote.
Whether Kalshi’s election contracts could be considered gaming or whether they serve a true risk-hedging purpose is one of the top questions the CFTC said it is weighing in its review.
Mansour started his career on Wall Street and said he saw there how institutional investors were able to structure trades that essentially hedged against election risks to their business, such as for Brexit. There are speculators in every market, but Mansour argued that the differing risks Americans face with each election gives prediction markets a different value and purpose than gaming.
“When you roll a dice or do a roulette spin, you are creating a risk that doesn’t need to be there,” Mansour said. “In financial markets like grain futures or insurance or election markets, that risk is already there.”
As the CFTC reviews the proposal, it is facing a lawsuit over its decision to revoke the no-action letter that another operator, PredictIt, has used to offer political event contracts in the U.S. since 2014. The CFTC in August ordered PredictIt, which is run by a university in New Zealand, to wind down by February. A group of academics, users, and the market’s technology provider have filed for a preliminary injunction against that decision, seeking to allow the exchange to continue through 2024.
When you roll a dice or do a roulette spin, you are creating a risk that doesn’t need to be there. In financial markets like grain futures or insurance or election markets, that risk is already there.”
The CFTC’s next moves will be closely watched. Kalshi is not the only firm building an events-contract marketplace. Polymarket, for instance, offers blockchain-based event-contracts trading, but only to users outside the U.S. The firm was ordered to close to Americans following a CFTC fine earlier this year.
One of its contracts asks whether the CFTC will approve Kalshi’s proposal. So far, its users are leaning toward no.
Update: The description of the CFTC deadline has been clarified.