As major bills like the CLARITY Act wind through Congress, the CFTC is set to inherit a large area of responsibility. It will have to monitor crypto markets for fraud, insider trading, and market manipulation as it faces staff cuts and an administration that is pro-crypto but anti-regulation.
Carol Goforth, the Clayton N. Little Professor of Law at the University of Arkansas School of Law, is one of the country’s experts on securities and crypto regulation. She has researched the shortcomings of American crypto regulation and suggested ways it can accommodate new technologies while providing guardrails against fraud. Goforth talked with Prediction News to unpack some of the pressing regulatory questions surrounding crypto and prediction markets at present.
As crypto and prediction markets merge, jurisdiction questions remain
Prediction markets are among the most popular crypto products. A crowdsourced database of prediction markets estimates that 240 of the 311 operating prediction markets are crypto platforms. CFTC-regulated Kalshi has even added crypto deposits to its platform and hired crypto influencer John Wang to find ways to target crypto users. And just this week, tokenized prediction markets powered by Kalshi went live on Solana blockchain.
However, regulatory authority over crypto raises difficult questions, not least of which being jurisdiction. Cryptoassets used to invest in a company could be securities, but currencies like Bitcoin behave more like commodities.
Crypto platforms like Polymarket will benefit from the clarity forthcoming legislation will bring to cryptocurrencies it uses for trading on its platform. There is a lot for Congress and the CFTC to untangle before crypto companies, including many new prediction markets, have full clarity about how they can operate in the United States.
“One of the huge problems for crypto over the past decade or more has been a lack of certainty as to who the regulator is, or are, if there’s more than one of them, and what is required in order to have a compliant platform and compliant asset and a compliant business model,” Carol Goforth told Prediction News.
Once a regulator and direction is determined, it’s going to be difficult to walk back whatever regulatory decisions are made by the next CFTC commissioners. A permissive CFTC now could make it difficult for a future set of commissioners to prohibit certain products, including sports contracts, though ongoing appellate court battles could change that.
Why crypto jurisdiction is an issue
The Securities Exchange Commission (SEC) regulates securities, which are intangible goods that only exist in financial markets. Additionally, the SEC requires the companies under its purview to disclose information about their products so investors have the maximum amount of information possible to invest based on their risk tolerances.
The SEC’s focus on disclosures has made it impossible for crypto platforms to register for the SEC and comply with its requirements. SEC-regulated products can only be traded on an SEC-regulated exchange. So, crypto platforms are out of luck.
“If I register as a security, I can’t find an exchange on which to trade my stuff. If I register my exchange as a securities exchange, none of the assets are listed as securities and they aren’t registered. So I’m going to be out of business either way. So you had the general perception that, essentially, the SEC was trying to put crypto assets and crypto asset businesses out of business or out of the country.”
It’s not easy to become SEC-regulated, either. Certain forms, like the S-1, can take 1,000 hours and require substantial legal teams to complete. The SEC requires the disclosure of material information, which is information a “reasonable investor” would weigh in an investment decision. Issuers, any company offering stocks or bonds, are the entities required to fill these forms out. In her paper How Active CFTC Enforcement Could Benefit Crypto, Goforth explained why these requirements are unrealistic for crypto assets and DeFi companies:
“…it may be unclear who is the ‘issuer’ of crypto assets, particularly in the DeFi…context, and it might be impossible to know reliably what information is ‘material’…Similarly, it may be impossible for any one person to describe how proceeds will be used, since it may be validators’ actions that lead to tokens being released, and each validator may have different plans for any payments.”
The CFTC’s monitoring requirements for crypto are still being hashed out. Designated Contract Markets (DCMs) can self-certify contracts by affirming that they comply with CFTC regulations. Once the CFTC finalizes those regulations for crypto companies, then companies can list crypto assets without making thousands of hours of disclosures before trading begins.
Historical context for the CFTC’s permissive approach
The SEC and CFTC approach enforcement from two different angles. While the SEC requires many disclosures up front, the CFTC monitors activity and only initiates enforcement actions if it sees evidence of wrongdoing.
“The SEC was designed to protect investors, while the CFTC came out of agricultural products, where they were trying to actually help not the consumer, but to help the farmers guarantee that they would be able to have a reasonable future baseline that they knew that they could sell their products for,” Goforth said.
Even though the CFTC was founded in 1974, the types of contracts the agency would regulate have been available since the late 1800s. Farmers faced uncertain harvests, so a single bad harvest could bankrupt them. With an increasing number of businesses using derivatives to hedge throughout the 1900s, the CFTC let the market decide which products would be launched, with the CFTC as a backstop rather than a gatekeeper having to approve contracts before companies could use them.
“It simply developed a practice of saying, ‘Here are the principles we want you to abide by, because…we have all kinds of commodities [for] underlying things that we are looking at, and no one set of rules is going to fit well for futures contracts in that particular industry with that particular commodity. So you guys tell us how you can guarantee reasonably anti-manipulation and full disclosure.’”
Guardrails against future CFTC backlash
The CFTC’s expanding authority will also follow in the wake of the 2024 Loper-Bright decision, which no longer required courts to defer to agency expertise when interpreting ambiguous statutes. That Supreme Court decision has important implications for a future CFTC that opposes sports contracts.
“If the courts think that the approach of President Trump was correct, it would be very hard to do an about face, because presumably you’ll be getting some precedent, some judicial opinions that say this interpretation is right and then it’s not something that the agency can just unilaterally undo.”
Federal agencies have some flexibility, but much of the leeway they have is constrained by Congress and the courts. So, if the courts rule in favor of companies like Kalshi in the prediction market cases over sports contracts, then the new CFTC will have case precedent to guide their decisions about how to regulate sports contracts.
“Absent a change in the legislation or a pretty significant change in the composition of the federal judiciary, those cases are going to constrain what a future set of commissioners has the authority to do.”
Unfavorable court rulings could constrain the contracts that crypto exchanges offer. They may not be able to offer sports contracts if courts rule that they are not within the CFTC’s authority to regulate.
However, if crypto assets are characterized as products separate from swaps or excluded commodities, then crypto exchanges could circumvent restrictions on sports contracts. Traditional exchanges that move to blockchains may also be able to get around judicial restrictions on sports contract offerings.
Looking ahead to a CFTC under Mike Selig
With crypto legislation on one hand and impending court decisions on the other, the guardrails on the traditionally permissive CFTC are about to be set in place.
President Trump’s latest CFTC Chairman nominee, Mike Selig, leads the SEC’s Crypto Task Force. He also worked on a letter arguing that the CFTC lacked the authority to prohibit sports contracts. In his nomination hearing last month, Selig said he would “look to the courts” to decide the sports contract question.
If crypto regulation gives Selig an opening to allow DCMs to offer sports contracts, then the incoming core of CFTC commissioners could pioneer a way for sports contracts to survive court rulings prohibiting them. That leeway will depend on the reasoning courts use to rule against sports contracts, if they go in that direction.
But if there’s an opening, it’s reasonable to expect Selig’s CFTC to take advantage of it.
