Prediction Markets Have A Market-Surveillance Problem

Prediction markets have moved far enough into mainstream finance for regulators to start asking an uncomfortable question. What happens when somebody trades on an event because they helped cause it?

The European Securities and Markets Authority raised concerns in September about crypto-based prediction markets, including the difficulty of policing insider trading and manipulation. The problem sits somewhere between securities surveillance, gambling regulation and blockchain enforcement. None of those systems was designed for a market where almost any real-world event becomes a tradable contract.

A conventional share trade has a defined issuer. Regulators know which executives possess material non-public information, exchanges monitor unusual activity and securities law establishes rules around disclosure and market abuse.

A trader might buy a contract paying out if a chief executive resigns, a company announces an acquisition, a politician leaves office or a regulator approves a product. Someone inside the event already knows more than the market. In other cases, a participant possesses enough influence to alter the outcome after taking a position. Blockchain settlement makes the transaction visible. It does not explain why the trader knew.

The wallet is visible. The person behind it often is not

Public blockchains record transactions with unusual precision. Investigators see when a wallet entered a market, what price it paid and when it exited. Traditional financial surveillance rarely provides such a clean public transaction history.

Identity remains harder.

A blockchain address does not automatically reveal whether its owner works for the company, advises a political campaign, participates in negotiations or simply made a good prediction. One trader also operates through several addresses, exchanges or intermediaries.

Market surveillance therefore needs information from outside the blockchain.

Consider a contract asking whether a listed company will announce an acquisition before a specific date. An employee involved in the transaction buys a large position through a fresh wallet three days before the announcement. Blockchain analytics identifies the profitable trade immediately after the news. Proving who controlled the wallet and whether securities rules apply requires another layer of evidence.

Prediction markets extend the same problem into areas with no conventional market-abuse framework at all.

Political staff know campaign decisions before voters do. Lawyers know litigation developments. Government employees see regulatory documents. Sports professionals possess information about injuries and team selection. Contractors know whether a project has met a milestone.

The closer prediction markets move towards specific corporate, political and economic events, the larger the population of potential insiders becomes.

Manipulation works differently when traders influence the event

Prediction markets also create a more awkward form of conflict when the trader has some control over the outcome.

Financial markets already deal with manipulation, but an investor buying a share normally cannot decide whether the company reaches its quarterly revenue target. Some event contracts operate differently.

A political operative trades on whether a candidate withdraws. A protocol delegate trades on the result of a governance vote. Someone involved in a product launch takes a position on whether the launch occurs before a deadline.

The financial incentive no longer sits entirely outside the underlying event. Decentralised governance makes the issue especially clear. Suppose a prediction market asks whether a protocol will approve a particular proposal. Token holders vote on the proposal while traders buy contracts on the outcome. A large token holder participates in both markets. Governance power and speculative exposure now sit inside the same transaction chain. Protocols need rules for that situation before the amounts become large enough to make the incentive material.

Market resolution introduces another concentration of power

Bitcoin does not need an external authority to determine whether a transaction occurred. A contract paying out on an election, court judgment or regulatory decision depends on information from outside the blockchain. Platforms use different mechanisms. Some rely on designated sources, others use decentralised oracle systems or dispute procedures. Each method has failure points.

An ambiguous event creates the clearest test. A company says it has “agreed” a transaction while legal completion takes another month. A politician announces an intention to resign but remains formally in office. A regulator grants conditional rather than final approval.

The contract wording decides which fact counts. Whoever interprets that wording can determine the distribution of substantial amounts of money. Oracle design therefore becomes part of market integrity rather than merely infrastructure.

Regulators are looking at a market that crosses old categories

Prediction platforms gained users because they convert dispersed information into a price. A contract trading at 72 cents gives an immediate numerical expression of what participants collectively believe about an outcome.

The useful information does not remove the regulatory problem. ESMA now faces crypto markets that connect more closely with traditional finance while retaining structures developed outside exchanges and broker-dealers. Tokenised equities add one form of connection. Stablecoins provide another. Prediction contracts create a third because traders increasingly use them to express views about interest rates, elections, companies and economic releases.

A platform that lists a contract on whether a central bank raises rates is not a bond exchange. Traders still use information about the same economic decision that moves bond, currency and equity markets.

Surveillance therefore has to follow the event rather than the legal label attached to the instrument. Prediction markets have already demonstrated that people will trade events far beyond sport and elections. The next stage asks less about whether those markets produce useful forecasts and more about who knew what before placing the trade, who had the power to influence the outcome and who decided which outcome finally occurred.