Prediction markets have experienced remarkable growth and evolution, recently gaining mainstream attention during the 2024 U.S. Presidential elections. These specialized marketplaces, where participants trade contracts tied to future events, have expanded from their historical roots into sophisticated financial instruments that span politics, economics, sports, and beyond. Following Kalshi’s landmark legal victory against the Commodity Futures Trading Commission (CFTC), the prediction market landscape is undergoing significant transformation, blurring lines between traditional gambling, financial technology, and forecasting tools.
History of Prediction Markets
The concept of prediction markets isn’t new—it’s actually centuries old. Records of election betting date back to 1503, when people placed wagers on papal succession candidates in what was even then described as “an old practice”. Throughout history, these markets functioned as informal forecasting mechanisms long before scientific polling existed.
Wall Street has hosted election betting markets since at least 1884, with historians Paul Rhode and Koleman Strumpf noting that betting turnover during U.S. presidential elections often exceeded 50% of campaign spending. These markets weren’t mere gambling ventures but served as serious information aggregation systems. Before World War II, election betting was widespread across America, operating openly through “betting commissioners” who held stakes and collected commissions. The practice was so established that major newspapers including The New York Times regularly published daily odds.
The theoretical foundations for modern prediction markets emerged through the work of economists Friedrich Hayek and Ludwig von Mises, who explored how markets efficiently aggregate dispersed information. Further intellectual support came from Francis Galton’s 1907 discovery that a group’s median estimate can outperform individual expert predictions—a phenomenon now known as “wisdom of crowds”.
Key Milestones in Market Development
Several pivotal developments transformed these informal betting markets into sophisticated forecasting tools. The modern era of electronic prediction markets began with the University of Iowa’s Iowa Electronic Markets, launched during the 1988 U.S. presidential election. This academic initiative demonstrated how structured markets could produce accurate forecasts of political outcomes.
Around 1990, Robin Hanson implemented the first known corporate prediction market at Project Xanadu, allowing employees to bet on scientific controversies like cold fusion. This early application showcased the potential for these markets beyond politics.
HedgeStreet, designated in 1991 as a regulated market by the CFTC, pioneered Internet-based speculation on economic events. Meanwhile, the Hollywood Stock Exchange, established in 1996, achieved remarkable success predicting Oscar nominees and winners, correctly forecasting 32 of 39 big-category Oscar nominees in 2006.
Corporate and Public Sector Adoption
Major corporations began recognizing the value of prediction markets in the early 2000s. In 2005, pharmaceutical giant Eli Lilly employed internal markets to forecast which development drugs had the best chances of advancing through clinical trials. That same year, Google announced its use of prediction markets for strategic forecasting, including product launch dates and office openings. Microsoft and HP followed with their own private forecasting markets.
The public sector also showed interest, with the Pentagon briefly promoting a Policy Analysis Market in 2003 before quickly canceling it amid criticism that it constituted a “terrorism futures market”.
The Technical Infrastructure and Performance
Prediction markets function through various contract designs that reveal different types of forecasts. Standard contracts link payoffs to specific events (like an incumbent winning an election), continuous variables (such as vote share), or combinations as in spread betting. Each design reveals different parameters: probabilities, means, or medians.
These markets offer several advantages over traditional forecasting methods:
-
They rapidly incorporate new information, with prices adjusting almost immediately to breaking news
-
Market prices typically follow a random walk pattern, indicating efficiency and resistance to simple arbitrage strategies
-
They provide incentives for information discovery and truthful revelation of beliefs
Empirical evidence supports their effectiveness. When comparing the Iowa Electronic Markets to Gallup Polls for presidential elections from 1988-2004, markets demonstrated an average absolute error of 1.6 percentage points compared to polls’ 1.9 percentage points. This forecasting advantage appears even larger over longer time horizons, as polling numbers tend to be excessively volatile through electoral cycles.
Similar success has been documented internationally, with successful applications in Austria, Australia, Canada, Germany, the Netherlands, and Taiwan.
Recent Legal Developments and Market Expansion
A pivotal moment for prediction markets occurred in October 2024 when Kalshi won its lawsuit against the CFTC. This court victory allowed for the revival of fully regulated election prediction markets in the United States, creating a precedent for broader market offerings.
Prior to this, the CFTC had restricted election markets, arguing they resembled gaming rather than financial derivatives. The commission had previously allowed limited academic use through platforms like PredictIt, but withdrew support in 2022. They also targeted crypto-based prediction market Polymarket, resulting in the company moving offshore and paying a $1.4 million fine.
Following Kalshi’s legal success, prediction market companies like Kalshi and Crypto.com surprised industry observers by expanding into sports events. This move was particularly noteworthy considering that CFTC regulations traditionally prohibited sports betting.
Entering the Sports Vertical: Advantages and Challenges
The expansion of prediction markets into sports betting represents a significant development in the industry. According to Bank of America analyst Shaun Kelley, futures contracts in prediction markets offer several benefits over traditional sportsbooks:
-
Higher betting limits
-
More favorable pricing
-
No taxation (unlike traditional bookmakers)
-
National accessibility (allowing residents in states where sports betting remains illegal, such as Texas and California, to place wagers through futures contracts)
However, Kelley also highlighted notable disadvantages:
-
Lower promotional offers
-
Limited market depth
-
Liquidity challenges
At their best, we see prediction markets as a complementary product that can drive new customers, expand the total area market of sports betting, and blur the line between sports betting and financial technology – Shaun Kelley
Future Outlook and Industry Impact
The future of prediction markets appears both promising and complicated. While they offer compelling advantages in aggregating information and providing forecasts, regulatory challenges remain. Kelley emphasized the need for regulatory clarity, suggesting that an upcoming roundtable between futures contract companies and the CFTC (scheduled for late March or early April 2025) could play a crucial role in establishing clearer guidelines.
Prediction markets could develop in several directions:
-
As complementary products to existing gambling options
-
As tools for businesses to forecast product performance and consumer behavior
-
As mechanisms for predicting economic indicators and outcomes
Kelley warned that “at their worst, they could be disruptive new entrants, with deepening products/markets, access to national scale and cost advantages that need to be closely monitored”.
Victory Against the CFTC: A Turning Point
Prediction markets stand at an interesting crossroads, having evolved from ancient betting practices to sophisticated financial instruments. Their ability to aggregate information, provide accurate forecasts, and adapt to various domains makes them valuable tools for businesses, policymakers, and individuals seeking insight into future events.
The recent legal victory of Kalshi against the CFTC marks a turning point for the industry, potentially opening doors for broader applications and market offerings. As prediction markets continue to expand into new verticals like sports betting, they further blur the boundaries between traditional gambling, financial technology, and forecasting methodologies.
Whether they ultimately complement or disrupt existing markets remains to be seen, but their continued growth and development suggest that prediction markets will play an increasingly important role in how we forecast and prepare for future outcomes.
