While it may seem odd that a financial advisor is writing about prediction markets, it’s the unique structure of the contracts that are most fascinating and the future implications this may have in investing in general. What started out looking as a fun way to potentially bet your political favorite (or long shot) has morphed into a significant disruptor, and potential death knell, to traditional gambling and sports betting, and potentially, the legacy custodian.
What Are Prediction Markets and How Do They Work?
Offering a dollar bet to your buddy whether he hits this next ball on the green has established a “prediction market” with a binary choice – either he hits it on the green and collects or he misses and loses.
In the internet age, this has manifested itself into prediction markets with similar binary choices, “Will Bitcoin reach $100,000 in 2024?”, “Will the government end the shutdown before November 25th?”, or “Will the Chiefs win the Super Bowl?”. In each of these scenarios, a value is assigned to the “yes” or “no” answer with the ability made to buy into the prediction. For example, if your answer was “no” for the Chiefs winning the Super Bowl, you may pay $0.88 to win $1 in total, giving you $0.12 in total gain due to the fact that it is highly likely one of the 31 other teams will win the Super Bowl rather than the Chiefs.
“The prediction market makers do not face this same roadblock. A conservative read on taxation of these contracts is to treat it as ordinary income with the ability to write off losses against gains.”
There are a number of providers that have gotten into this business – Kalshi and Polymarket are among some of the best known. It was very uncertain as to whether or not these constituted gambling or was actually something that traded more like a security, and therefore was not offered in the U.S. – until recently.
How Kalshi’s Regulatory Approval Changed Prediction Markets Forever
Kalshi, founded in 2018, wisely did not position itself as an entity that offered unlicensed gambling. Instead, it registered with the Commodity Futures Trading Commission (CFTC) as a federally regulated derivatives exchange. It obtained its license in 2020 to operate as a designated contract market (DCM). This unique regulatory path allowed it to be out in front of other competitors and came down to a huge decision on October 2nd, 2024, when Kalshi was able to offer election betting markets after the U.S. Court of Appeals upheld a lower court’s order to allow the contracts.
Since then, Kalshi has been able to operate as a regulated provider of event contracts in the U.S., with Polymarket set to follow in late 2025.
Why Prediction Markets Threaten Traditional Sportsbooks and Gambling Platforms
Over the past few years, online sports betting has exploded in popularity and legality across many U.S. states, with offshore platforms adding even more options. Gone are the days of calling your local bookie—now you can bet on any game, any time, down to individual player props.
In traditional sportsbooks, this convenience comes with a hidden cost: the rake (also called vig or juice). The house doesn’t just facilitate bets—it acts as the market maker, setting odds slightly in its favor. Typically, you’ll see -110 lines on both sides of a bet, meaning you have to risk $110 to win $100. That extra $10 on each side? That’s the “rake”, which is the bookmaker’s cut for providing liquidity and taking the other side of your wager.
Here’s where Kalshi and Polymarket’s role as regulated derivatives comes in.
Remember from above that they are prediction markets, so instead of the platform taking the opposite side of your bet (and charging a rake), users trade directly with each other on event outcomes, such as “Will the Chiefs cover the spread?” or “Will Player X score over 25.5 points?”
Because there’s no house acting as counterparty, Kalshi and Polymarket don’t charge a traditional rake on the spread. Their revenue comes from small trading fees (e.g., 0.5-2% per trade or settlement), which are typically much lower than the 4.5-10% implied rake at the typical sportsbook.
Upcoming Tax Changes Could Tilt the Odds Against Sportsbooks
Typically in the past with sportsbooks, gambling gains could be offset by gambling losses (and at those rakes, making money long term is challenging!) and gains will show up as ordinary income. Starting in 2026 due to the One Big Beautiful Bill Act (OBBBA), only 90% of gambling losses can be deducted. If you break even, you will be responsible for phantom income even though you didn’t even win because you can’t deduct your full losses against your gains!
The prediction market makers do not face this same roadblock. A conservative read on taxation of these contracts is to treat it as ordinary income with the ability to write off losses against gains. This avoids the 90% cap on losses of the OBBBA, giving the prediction markets not only an edge on the rake, it gives it an advantage in taxation as well. There is also a chance, or by using a more aggressive read of the contracts, that the prediction markets could end up with even more favorable tax treatment through a portion being allowed as capital gains. Presently there is no official IRS guidance here on this, so tread carefully and work with a tax professional.
With these headwinds for sportsbooks and the metamorphosis of the prediction markets in offering sports betting alongside many other trading opportunities, it is not hard to connect the dots and predict that we may be seeing a significant threat to sportsbooks and betting sites. The markets have already reacted to this news, here is a recent post on Draftkings (DKNG).
How Prediction Markets Could Disrupt Legacy Financial Custodians
Legacy custodians such as Fidelity or Schwab may also find themselves under some pressure by these upstart prediction markets. Instead of having to go through fairly extensive online opening protocols, Kashi or Polymarket offers the ability to trade event contracts on stocks, such as, “Will NVDA end the 11/5/2026 trading day with a positive return?”. While this may not be a threat to a buy-and-hold investor, it could definitely replace, or augment, an options strategy.
Some custodians such as Robinhood and Interactive Brokers already offer prediction markets (Robinhood’s is powered by Kalshi), and Schwab’s CEO Rick Wurster is already sounding the alarm bells despite their former founder, Charles R. Schwab himself, investing directly into Kalshi! With this backdrop and the eventual tokenization of stocks, will we find custodians being forced into offering all flavors of alternatives to investors? It’s looking increasingly likely, and that’s not necessarily a bad thing to push these custodians into the modern age. Recent news has Polymarket partnering up with Yahoo Finance, less than a week after Google Finance said it would integrate prediction market data from Kalshi and Polymarket into its search results.
Are Prediction Markets a Legitimate Investment Opportunity?
Being someone that enjoys the numbers behind prediction markets and stealing from the band Oasis, I’ll give it a “Definitely Maybe”. I don’t know if you want your financial advisor taking the money line on the Jets in the MNF game in your Roth IRA. That being said, there could certainly be a use case where you could see very analytical investment managers build portfolios and take small wins on high probability events. This could provide a potential return source out of assets that are outside of traditional stocks and bonds, giving an uncorrelated, and market neutral, source for gains. For the general public, given the very poor rates of sports bettors that actually make money (3-5%!), prediction markets are unlikely to provide long term rates of return for portfolios…so before you go all-in on the surging Colts to win the Super Bowl or the #1 free app in the Apple Store on a certain date, make sure it’s money you are willing to lose.
