Guide
Prediction Markets
How markets aggregate probability estimates, the CFTC regulatory framework, and how institutional counterparties use prediction market contracts to hedge event-driven risk.
What is a prediction market?
A prediction market is a financial contract whose settlement value is determined by a real-world event outcome. Participants trade shares that pay $1 if an event occurs and $0 if it does not. The market price — always between $0 and $1 — reflects the collective probability estimate assigned to that event by all participants.
Unlike opinion polls or analyst forecasts, prediction markets impose financial stakes on every probability estimate. A participant who believes a 30% implied probability is too low must buy at that price and will lose money if wrong. This discipline tends to produce probability estimates that are well-calibrated relative to expert forecasts.
The regulatory framework
In the United States, prediction market contracts on economic events are regulated as swaps or event contracts under the Commodity Exchange Act. The Commodity Futures Trading Commission oversees Designated Contract Markets (DCMs) that list event contracts for retail participants and approves Swap Execution Facilities (SEFs) for institutional OTC trading.
The 2023 KalshiEX LLC v. CFTC litigation and the subsequent D.C. Circuit ruling clarified that event contracts on political events (elections, congressional control) are not categorically excluded from CFTC jurisdiction — significantly expanding the scope of permissible prediction market activity.
Bilateral OTC event contracts between eligible contract participants (ECPs) — generally institutions with assets over $10 million — are regulated as swaps under Section 2(h) of the CEA and do not require exchange execution, provided neither party is a swap dealer.
How institutions use prediction markets
Institutional counterparties use prediction market contracts for three primary purposes:
- Revenue-driver hedging. A business whose revenue correlates with a specific event (a rate decision, a weather outcome, a regulatory change) can offset that correlation by taking a position that pays if the adverse event occurs.
- Tail-risk protection. Low-probability, high-severity events — a regulatory ban, a major leadership transition, a sudden macro shock — are difficult to hedge with traditional instruments. Event contracts can be sized precisely to cover a specific loss scenario.
- Portfolio calibration. Asset managers use prediction market prices to calibrate scenario probabilities in risk models, rather than relying on analyst consensus or historical frequency.
Price discovery and information efficiency
Academic research consistently shows that prediction markets outperform expert panels and structured forecasting processes on a wide range of event types — election outcomes, economic releases, corporate earnings, and geopolitical events. The mechanism is straightforward: aggregation of dispersed private information through price competition eliminates the systematic biases present in expert polls (anchoring, availability heuristic, social desirability).
For institutional users, this has a practical implication: prediction market prices for events that affect your business are likely to be more accurate than internal forecasts, making them better hedging reference prices.
Prediction markets vs. insurance and futures
| Feature | Insurance | Futures | Event Contracts |
|---|---|---|---|
| Reference | Insurable loss | Standardized asset | Any real-world event |
| Settlement | Claims process | Daily mark-to-market | Binary or tiered at resolution |
| Regulation | State insurance law | CFTC / exchange rules | CEA swap rules (ECPs) |
| Customization | Limited | Low (standardized) | Full (bilateral OTC) |
| Minimum size | No minimum | Contract-size dependent | ECP threshold ($10M AUM) |
Tomorrow's approach
Tomorrow operates as a bilateral OTC venue where eligible institutions negotiate and execute event contracts directly. Contracts reference real-world events — regulatory decisions, executive continuity, macro releases, sports outcomes — and are documented under ISDA framework agreements.
Because trading is bilateral and not exchange-executed, participants are not subject to exchange membership requirements, standardized contract terms, or retail reporting obligations. AI agents handle initial pricing, negotiation, and documentation — reducing the time from exposure identification to executed contract from weeks to hours.