Do Gambling Laws Threaten Prediction Markets?

Because prediction market traders generally rely more on skill than on chance to win, I've argued that they do not qualify in "gambling" as defined by U.S. law. I've also admitted, however, that over-ambitious prosecutors might see the matter differently. A recent email exchange I had with Prof. George R. Neumann, who serves on the Board of Directors of the Iowa Electronic Markets, confirmed my worries. I here quote him, with his permission.

"We have been threatened several times with suits by various states," he wrote, "but so far the CFTC coverage [i.e., the two 'no action' letters that the CFTC gave the IEM] has been our trump card." Prof. Neumann offered this example: When the IEM ran a market on Hilary Clinton's run for the New York Senate seat, an N.Y.C.-based district attorney "contacted us (via a very nasty letter) to tell us that NY had a law that forbade gambling on elections in that state. He demanded a list of each and every NY State resident who was a participant in our market." Wielding the CFTC's "no action" letter in defense of the IEM, Prof. Neumann directed the DA to file suit in, um, a venue at once very local and yet very inconvenient.

Alas for those who would like to match Neumann's feat of legal acumen, the CFTC's treatment of the IEM so far looks like a one-shot deal. Or, rather, it looks like a big-shot deal; you would probably need some political help to squeeze another such letter out of the CFTC. While you're at it, please ask the CFTC to issue an advisory opinion saying, "The CFTC has no rationale to regulate transactions or markets in which price discovery functions predominate over hedging functions." It could state a market cap limit to make clear the limits on its discretion.

Such a "public no action letter" would give a great many useful prediction markets freedom to help us discern the future, just as the IEM has done. It would also, to judge from the IEM's experiences, give new prediction markets a shield from state anti-gaming prosecutions.

[Crossposted to Midas Oracle.]