Prediction Markets Regulation 2026: Why States May Hold the Edge Over CFTC in Jurisdictional Fight

A recent analysis from TD Cowen suggests that state regulators—not the CFTC—may ultimately prevail in the escalating jurisdictional battle over prediction markets, including crypto-based platforms like Polymarket. For an industry that has operated in a regulatory gray zone for years, this assessment carries significant implications: the difference between federal commodities oversight and state gambling regulation could determine whether blockchain-based prediction markets can operate legally in the United States.

The stakes are high. Prediction markets surged in public visibility during the 2024 election cycle, and crypto-native platforms have grown rapidly since. But the fundamental legal question—whether prediction markets constitute regulated financial instruments or gambling—remains unresolved. How that question is answered, and by whom, will shape the compliance landscape for the foreseeable future.

Key Takeaways

• Federalism favors the states. States possess deep historical authority over gambling under their police powers. TD Cowen’s analysis suggests the CFTC may not be able to displace that authority over prediction markets—even those built on blockchain infrastructure.
• Federal law already defers to state gambling definitions. The Unlawful Internet Gambling Enforcement Act (UIGEA), 31 U.S.C. § 5361 et seq., explicitly incorporates state gambling law as the baseline for determining what constitutes unlawful internet gambling—reinforcing state primacy rather than displacing it.
• The CFTC’s event contract authority is narrower than it appears. The Dodd-Frank Act empowers the CFTC to prohibit certain event contracts involving “activity unlawful under any State or Federal law” (7 U.S.C. § 7a-2(c)(5)(C))—language that arguably reinforces, rather than preempts, state regulatory authority.
• Crypto-based prediction markets face compounded regulatory exposure. Platforms using cryptocurrency for settlement must navigate both the prediction market jurisdictional question and state money transmitter licensing—a dual compliance burden with no clear safe harbor.
• No definitive court ruling has settled the federal-state boundary. While Kalshi, Inc. v. CFTC, No. 23-cv-3257 (D.D.C. 2024), addressed whether the CFTC could block certain political event contracts on a registered exchange, it did not resolve the broader question of state versus federal primacy over prediction markets generally.

What Is the CFTC’s Claim to Prediction Market Jurisdiction?

The CFTC’s authority over prediction markets derives from its mandate to regulate derivatives and commodity trading under the Commodity Exchange Act (CEA), 7 U.S.C. § 1 et seq. Event contracts—binary options that pay out based on the outcome of a future event—can fall within the CEA’s definition of “commodity” under certain interpretations. The CFTC has historically required prediction market platforms to register as Designated Contract Markets (DCMs) or obtain no-action relief.

The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 added Section 745, codified at 7 U.S.C. § 7a-2(c)(5)(C), which granted the CFTC authority to review and potentially prohibit event contracts that involve “activity unlawful under any State or Federal law” or relate to terrorism, assassination, or war. This provision is framed as a prohibition power—not an affirmative grant of exclusive regulatory jurisdiction. Congress appears to have contemplated that some event contracts would implicate state law, and it built in a mechanism for the CFTC to defer to state prohibitions rather than override them.

The CFTC has exercised this authority unevenly. It permitted the Iowa Electronic Markets to operate under a longstanding no-action letter for decades. It approved Kalshi as a DCM but then attempted to block Kalshi’s political event contracts—a decision overturned in Kalshi, Inc. v. CFTC, No. 23-cv-3257 (D.D.C. 2024), where the court found the CFTC had not adequately justified its prohibition. In the crypto space, the CFTC settled an enforcement action in January 2022 against Blockratize, Inc. d/b/a Polymarket for operating an unregistered facility for trading binary options (CFTC Order, In re Blockratize, Inc. d/b/a Polymarket, Jan. 3, 2022), resulting in a $1.4 million civil monetary penalty.

Why Do States Have the Stronger Historical Claim?

State regulation of gambling is among the oldest and most deeply rooted exercises of state police power in American law. The Supreme Court has long recognized states’ broad authority to regulate or prohibit gambling within their borders. In Murphy v. NCAA, 584 U.S. 453 (2018), the Court struck down the Professional and Amateur Sports Protection Act (PASPA) as an unconstitutional commandeering of state regulatory authority, holding that Congress cannot dictate whether states must prohibit or permit sports gambling.

While Murphy addressed the anti-commandeering doctrine rather than federal preemption directly, its reasoning strongly supports the proposition that gambling regulation is a core state function that federal law displaces only when Congress speaks clearly. Under the presumption against preemption articulated in Rice v. Santa Fe Elevator Corp., 331 U.S. 218, 230 (1947), courts assume Congress does not intend to supplant state law in areas of traditional state regulation unless it makes that intention “clear and manifest.” Gambling regulation sits squarely within that protected zone.

Critically, existing federal gambling statutes reinforce rather than displace state authority. The UIGEA, enacted in 2006, does not create an independent federal definition of “unlawful internet gambling.” Instead, 31 U.S.C. § 5362(10)(A) defines the term by reference to bets or wagers that are “unlawful under any applicable Federal or State law.” This structure means that whether an online prediction market constitutes illegal gambling depends, in the first instance, on the law of the state where the bettor is located. The Federal Wire Act, 18 U.S.C. § 1084, similarly targets gambling activity that violates underlying state law.

TD Cowen’s analysis builds on this framework: even active CFTC intervention may not overcome the structural advantage states hold in this domain. If a state classifies prediction market contracts as gambling under its own statutes, the CFTC’s commodities framework may not preempt that classification absent explicit Congressional authorization that does not currently exist.

The Skill-Versus-Chance Question

Whether prediction markets constitute “gambling” under state law often turns on a threshold question: does the activity involve predominant chance or predominant skill? States vary significantly in how they draw this line.

A majority of states apply some version of the “predominant purpose” or “dominant factor” test, asking whether chance or skill is the primary determinant of outcomes. See, e.g., Morrow v. State, 511 P.2d 127 (Alaska 1973). A minority of states apply the stricter “material element” test, under which an activity constitutes gambling if chance is any material element—even if skill predominates. See, e.g., N.Y. Penal Law § 225.00(2).

Prediction market operators have argued that their platforms involve informed analysis and research—more akin to financial trading than roulette. There is some force to this argument for markets on topics like economic indicators or policy outcomes, where participants with superior information or analytical skill may have a genuine edge. But the argument is weaker for markets on pure-chance events (e.g., weather outcomes, coin flips) and is untested in most state courts. Importantly, even in “skill” states, the classification of any particular prediction market contract will depend on the specific subject matter and market design—not on the platform’s self-characterization.

Where Does This Leave Crypto Prediction Markets?

Blockchain-based prediction markets face a uniquely challenging compliance landscape because the crypto element does not simplify the jurisdictional analysis—it compounds it. A platform that settles prediction market contracts in USDC on a Layer 2 network must contend with at least four overlapping regulatory frameworks:

First, event contract classification under the CEA. If the underlying contracts are “swaps” or “commodity options” under the CEA, CFTC registration requirements apply regardless of the settlement mechanism. The CFTC’s enforcement action against Blockratize/Polymarket confirmed the Commission views unregistered crypto prediction markets as within its enforcement reach.

Second, state gambling law. If states classify prediction market wagers as gambling, operators face potential prosecution under state penal codes—many of which carry criminal penalties. State attorneys general have become increasingly active in crypto enforcement, and characterizing a prediction market as illegal gambling would not require novel legal theories in most jurisdictions.

Third, money transmission. Platforms that accept, hold, or transmit cryptocurrency may trigger state money transmitter licensing under applicable state statutes. See, e.g., N.Y. Fin. Servs. L. § 641 et seq. (BitLicense); Cal. Fin. Code § 2000 et seq. (Digital Financial Assets Law). FinCEN registration as a money services business (MSB) under 31 C.F.R. § 1010.100(ff) may also be required at the federal level.

Fourth, potential securities law implications. Depending on the token economics, governance tokens or participation tokens associated with prediction market platforms could constitute investment contracts under SEC v. W.J. Howey Co., 328 U.S. 293 (1946). This is particularly relevant for platforms that distribute governance tokens to liquidity providers or market makers.

Has Congress Weighed In?

Congressional action on prediction markets has been limited and largely indirect. CFTC reauthorization discussions in the 118th and 119th Congresses touched on event contract authority but did not produce legislation clarifying the federal-state boundary for prediction markets specifically. The broader digital asset bills under consideration—including the Financial Innovation and Technology for the 21st Century Act (FIT21) and its successors—have focused primarily on the SEC-CFTC jurisdictional divide for digital assets rather than prediction market classification.

Without explicit federal preemption legislation, the default rule under Rice v. Santa Fe Elevator Corp. favors concurrent state authority. Congress knows how to preempt state gambling law when it chooses to—it did so with the Indian Gaming Regulatory Act, 25 U.S.C. § 2701 et seq., and the Interstate Horseracing Act, 15 U.S.C. § 3001 et seq. The absence of comparable preemption language for prediction markets is itself significant.

Practical Implications

For Prediction Market Operators

• Assume state jurisdiction applies. Until a federal court definitively holds that CFTC jurisdiction preempts state gambling law for prediction markets, operators should conduct a state-by-state analysis of gambling statutes in every jurisdiction where they have users.
• DCM registration may not provide a complete shield. Even CFTC-registered platforms should not assume federal registration preempts state gambling claims. Whether DCM status provides an implied preemption defense in the prediction market context remains untested.
• Implement robust geofencing. Platforms should maintain and document IP-based and KYC-based geofencing to exclude users in states with restrictive gambling laws or where the legal analysis is unfavorable.
• Engage proactively with state regulators. Seeking advisory opinions or no-action positions from key state gambling commissions and financial regulators can reduce enforcement risk and demonstrate good-faith compliance.

For Investors and Users

• Understand your state’s gambling laws. Participation in prediction markets—whether crypto-based or traditional—may violate state gambling statutes depending on your jurisdiction of residence, even if the platform holds CFTC registration.
• Tax treatment is unsettled. The IRS has not issued specific guidance on prediction market gains. They could be characterized as gambling winnings (reported on Schedule 1 or Form W-2G), capital gains (Form 8949), or ordinary income depending on how the underlying contract is classified. Consult a tax professional familiar with both gambling and digital asset taxation.

What to Do Now

• Prediction market operators: Engage regulatory counsel to map state-by-state exposure under gambling statutes, independent of any CFTC registration or compliance framework. Prioritize the skill-versus-chance analysis for each contract type offered on the platform.
• Crypto platforms exploring prediction market features: Conduct comprehensive legal analysis before launch, accounting for CEA event contract rules, UIGEA, state gambling laws, money transmission requirements, and potential securities implications of associated tokens.
• Compliance teams: Monitor state legislative sessions for prediction market-specific bills, particularly in states with sophisticated gambling regulatory frameworks—New Jersey, Nevada, Pennsylvania, and Michigan—that may seek to bring prediction markets within existing licensing regimes.
• All market participants: Watch for any federal court decision directly addressing whether CFTC jurisdiction preempts state gambling authority over prediction markets. Such a ruling would fundamentally reshape the compliance landscape.

Conclusion

The TD Cowen analysis highlights a jurisdictional reality that the prediction market industry has been reluctant to confront: the CFTC’s claim to regulate prediction markets, while grounded in the CEA, exists in tension with centuries of state authority over gambling—authority that Congress has repeatedly reinforced through statutes like the UIGEA and the Wire Act. For crypto-based prediction markets, this tension is compounded by the additional regulatory layers that blockchain settlement introduces.

Until Congress enacts explicit preemption legislation or a definitive court ruling establishes clear jurisdictional boundaries, prediction market operators—especially those in the crypto space—should plan for a compliance environment where both federal and state regulators assert authority, and where state regulators may ultimately hold the stronger hand. This is not a theoretical concern. It is a compliance planning imperative.

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This article is for informational and educational purposes only and does not constitute legal advice. Reading this content does not create an attorney-client relationship. Laws and regulations in the cryptocurrency space change rapidly — consult a qualified attorney for advice specific to your situation and jurisdiction. Seth Goettelman is licensed to practice law in Wisconsin and Florida.