Yesterday, the Department of Justice and the CFTC sued three states — Illinois, Arizona, and Connecticut — for trying to shut down prediction market operators. The states had sent cease-and-desist letters to Kalshi, Polymarket, Crypto.com, and Robinhood, arguing these companies were offering unlicensed sports gambling products under state law.
The federal government's position: prediction markets are swaps. The Commodity Exchange Act gives the CFTC exclusive jurisdiction over swaps. Federal law preempts state gambling regulations. Case closed.
The states' position: these are bets on sporting events. States regulate gambling. Companies offering unregulated gambling products to state residents are violating consumer protection law. Case closed.
Both sides have a coherent legal argument. Neither side has a coherent answer for what prediction markets actually are in 2026 — or what the classification choice means for the people and institutions that have to account for, report on, and pay taxes on the transactions flowing through them.
The Classification Problem
The CFTC's position is that event contracts are "derivative instruments that enable parties to trade on their predictions about whether a future event — which may relate to economics, or elections, or climate, or sports, or anything else of a potential financial, economic or commercial consequence — will occur."
That's the language from the actual filing. Read it carefully: the CFTC is claiming jurisdiction over contracts on anything that might happen. Elections. Weather. Sports. Whether a CEO gets fired. Whether a bill passes Congress. Whether it rains in Denver next Tuesday.
If that sounds like an extraordinarily broad claim of regulatory authority, it is. The CFTC is essentially arguing that any binary outcome contract — regardless of the underlying event — is a swap, and therefore falls under its exclusive purview.
The states, meanwhile, are looking at platforms where users wager money on whether the Lakers beat the Celtics tonight, and asking a reasonable question: how is this not sports gambling?
Both framings have consequences. And those consequences extend far beyond which regulator gets to write the rules.
Why "Swaps" Creates Accounting Problems
If prediction markets are swaps — and that's the federal government's legal position as of this week — then every participant in a prediction market is holding a derivatives position.
This has immediate implications for anyone with reporting obligations.
Under ASC 815 (Derivatives and Hedging), entities that hold derivative instruments must recognize them at fair value on the balance sheet, with changes in fair value flowing through earnings unless specific hedge accounting criteria are met. For corporate treasury operations using prediction markets to hedge business risks — which is already happening — this means mark-to-market volatility hitting the income statement every quarter.
For funds and institutional participants, the classification triggers specific disclosure requirements, margin considerations, and potentially different regulatory capital treatment. A prediction market position classified as a swap has different risk-weighting implications than the same economic exposure classified as a wager.
For individual participants — and platforms like Kalshi and Polymarket have millions of them — the tax treatment of swap gains and losses differs from gambling gains and losses in ways that matter. Swap losses can offset ordinary income in certain structures. Gambling losses can only offset gambling gains. The classification determines not just which regulator oversees the market, but how every participant reports the economic outcome.
Nobody in the current legal battle is talking about this.
Why "Gambling" Doesn't Fit Either
The states' gambling classification has its own structural problems.
The core function of a prediction market is price discovery — aggregating dispersed information into a probability estimate that reflects the collective assessment of informed participants. This is economically identical to what futures markets do. When the prediction market on "Will the Fed cut rates in June?" settles at 73 cents, it's performing the same information-aggregation function as a Fed funds futures contract on the CME.
Classifying that as gambling ignores its actual economic function and creates a regulatory framework that's hostile to the most socially valuable use cases. Corporate risk managers using prediction markets to hedge event-driven exposure aren't gambling — they're managing risk. Researchers using prediction market prices as probability estimates aren't consuming entertainment — they're gathering data.
The gambling frame also fails to account for the emerging integration between prediction markets and financial infrastructure. Prediction market prices are being used as inputs to insurance models, credit risk assessments, and treasury management decisions. Treating those price signals as gambling outcomes poisons the entire downstream chain.
What Prediction Markets Actually Are
Here's the uncomfortable truth that neither the CFTC nor the state gaming commissions want to acknowledge: prediction markets are a new financial primitive that doesn't cleanly fit either existing category.
They share characteristics with swaps: binary payoff structures, market-determined pricing, counterparty exposure (or protocol-level settlement in the case of crypto-native platforms). They share characteristics with gambling: entertainment value, retail participation, event-driven speculation on outcomes with no direct financial consequence to the bettor.
But they also have properties that neither category captures. Prediction markets are information markets — their primary economic output is a continuously updated probability estimate that has value independent of any individual participant's position. That information function has no analogue in gambling regulation and is only partially captured by derivatives regulation.
The CFTC's "exclusive jurisdiction" claim might win in court — the Commodity Exchange Act's preemption language is broad, and the current Commission is clearly motivated to assert it. CFTC Chairman Mike Selig's statement was explicit: "Congress specifically rejected such a fragmented patchwork of state regulations."
But winning the jurisdiction fight doesn't solve the classification problem. It just means the CFTC gets to deal with the downstream consequences alone.
The Compliance Gap Nobody Is Filling
The practical impact of the current regulatory uncertainty falls on three groups that have almost no voice in the debate.
Accountants and auditors. If your client holds prediction market positions, what are they? Derivatives under ASC 815? Gambling activity? Something else? The answer determines balance sheet presentation, income statement treatment, and footnote disclosures. Right now, there's no authoritative guidance. Firms are making judgment calls, and those judgment calls are inconsistent across the industry.
Tax preparers. An individual who made $50,000 on Kalshi last year needs to report that income. Is it a capital gain from a derivative instrument? Is it gambling income reported on Schedule 1? Is it a Section 1256 contract eligible for 60/40 long-term/short-term treatment? The answer depends on a classification question that the federal government and three state governments are currently litigating. The return is due in two weeks.
Compliance officers at the platforms themselves. Kalshi is CFTC-regulated. Polymarket's offshore platform is not. Robinhood and Crypto.com are offering prediction market products alongside traditional brokerage services. Each of these entities has different reporting obligations, different KYC/AML requirements, and different customer protection frameworks depending on which regulatory classification prevails. Operating in regulatory limbo isn't a theoretical inconvenience — it's an active compliance risk with real enforcement exposure.
Where This Is Heading
The legal fight will take years. The CFTC is heading to the Ninth Circuit later this month. Nevada already secured a temporary restraining order against Kalshi. Congressional scrutiny is intensifying. The resolution — if there is one — will likely require legislation that creates a purpose-built regulatory framework for event contracts, rather than forcing them into existing categories.
In the meantime, the prediction market industry is growing at exponential pace. Kalshi and Polymarket are household names. Robinhood and Crypto.com are onboarding millions of users into event contract trading. Sports-adjacent contracts are driving massive retail volume.
The volume is real. The tax obligations are real. The accounting questions are real. And the people responsible for answering those questions — CPAs, tax attorneys, compliance professionals, auditors — have no authoritative framework to work with.
Three things need to happen, and none of them are on anyone's current roadmap:
1. FASB needs to issue guidance on event contracts. Not someday. Now. The classification question — derivative instrument, gambling activity, or sui generis financial product — determines everything downstream. An Accounting Standards Update that addresses the recognition, measurement, and disclosure requirements for event contract positions would eliminate the largest source of inconsistency in current practice.
2. The IRS needs to clarify the tax treatment. Is a prediction market gain a capital gain, ordinary income, or gambling income? Is there Section 1256 treatment available for exchange-traded event contracts? What are the reporting obligations for platforms? A Revenue Ruling or Notice addressing these questions would save millions of hours of professional uncertainty.
3. Congress needs to legislate a new category. Prediction markets are not swaps. They are not gambling. They are information markets with speculative characteristics that serve a genuine price-discovery function. The regulatory framework should reflect that — with consumer protections appropriate to the retail participant base, reporting requirements appropriate to the financial nature of the instruments, and a jurisdictional structure that doesn't require federal courts to resolve every state-level disagreement.
None of this is likely to happen quickly. But the longer the classification remains unsettled, the more the compliance burden shifts to practitioners who are making it up as they go — and the more the regulatory uncertainty functions as a tax on the very information-discovery function that makes prediction markets worth having.
The federal government and the states are fighting over who gets to regulate prediction markets. The more important question — how they should be regulated, accounted for, and taxed — isn't even on the table yet.
That's the real problem.