Prediction Markets Explained - How They Work, Legality & Risks in 2026

What Are Prediction Markets and Why Do They Matter?

Prediction markets are platforms where you can buy event contracts tied to specific outcomes in sports, politics, economics, and other domains.

To have prediction markets explained further, you must understand the “wisdom of the crowd” concept. It suggests that if there are large numbers of people whose beliefs align, the event is more likely to end as they predicted.

For example, the 2025 elections were correctly predicted on prediction markets, proving they go beyond mere speculation and are more precise than traditional polls.

How Prediction Markets Differ From Traditional Betting

The prediction markets vs sports betting comparison yields some crucial differences between the two platform types. If you wonder how prediction markets are not gambling, check the table for this and many other answers:

A Brief History: From Papal Wagers to Polymarket

It all started a long time ago with papal wagers in the 16th century. Years later, in the late 1980’s in the USA, academic and corporate spaces, such as Iowa Electronic Markets, emerged.

Nowadays, we have decentralized, high-volume platforms like Polymarket and Kalshi that use crypto and FIAT currencies and have tons of users daily.

This short history of prediction markets is a great warm-up for a deeper dive into prediction markets mechanics.

How Do Prediction Markets Work? - The Core Mechanics

Prediction markets work based on binary (“yes” and “no”) contracts priced between $0 and $1 (e.g., ¢60). Specifically, prediction market betting is about buying and selling shares based on future outcomes. The platforms appear as desktop sites, prediction market apps, or both.

Let’s further explore the core functions of prediction markets.

Share Pricing and Implied Probability Explained

Once a market goes live, traders can buy a “yes” or “no” contract at a certain price. But the moment the first purchase (and those that follow) is made, the market price will change as it becomes more popular.

So, that is how market popularity determines the price, and the price determines the implied probability (in prediction markets, price = implied probability). For example, if a market is priced at $0.07, it means there is a 7% chance it will occur.

How Prediction Markets Resolve and Pay Out

Prediction markets resolve and pay out based on the event outcome. If successful, a contract will pay the difference between $1 and the price at which it was bought. If unsuccessful, the contract will expire at $0, without the funds it was bought with returned.

A great job here is done by third-party trusted data sources or “oracles”, which verify the final truth. Such sources that determine what really happened and convert it into a real-world event binary outcome that settles each contract.

Can You Exit a Position Early?

Yes, you can exit a position early on any market or contract, at any price, regardless of whether it’s the politics section or any other.

Moreover, you can buy a contract at one price, and then, if there’s a surge of traders buying it, it will quickly change price, at which you can exit, i.e., sell the contract, and lock in a profit.

How Do Prediction Markets Make Money?

Prediction markets make money by charging fees, usually on one of the following occasions:

• After a trader’s contract has settled as “win”, the platform takes a part of the winnings.
• During traders’ deposits or withdrawals (not to be confused with gas fees).
• When there’s “spread”.
• While users are making trades (with fixed or flexible fees for every contract bought or sold).
• As users’ funds are being held, platforms can earn interest on them.

Are Prediction Markets Legal in the US?

Prediction markets are legal in the US, and they operate under Federal law. As such, these platforms are available in all states. Still, users shouldn’t be confused by this; it doesn’t mean that every prediction market is available in all 50 states, but that it can be, in theory.

To learn more about how prediction markets are legal in the US, check the following passages.

Federal Regulation: The Role of the CFTC and SEC

Prediction markets regulation is based on the Commodities Futures Trading Commission oversight. This is an independent USA agency responsible for regulating speculative platforms.

At first, predictions about politics weren’t allowed because it was a sensitive topic and could be influenced. However, recent landmark federal court rulings have limited the CFTC’s power, allowing prediction markets to offer this type of event.

In addition to the CFTC, there’s the Securities and Exchange Commission (SEC), which may also have jurisdiction if prediction markets resemble securities or financial derivatives.

On such an occasion, there’s regulatory overlap because the SEC is also in charge of overseeing the aforementioned digital activities involving real money.

Prediction Market Legal Status by State

As mentioned, prediction markets are legal in every US state, but not every platform is available in every state. Yet although Federal law allows such platforms to operate, there are exceptions: some platforms aren’t permitted to offer their full market selection due to local limitations.

Let’s see where trading is fully available and where it is a bit restricted:

How to Make Money on Prediction Markets?

To make money on prediction markets, you can use a variety of tactics.

First, you can capitalize on mispriced information, i.e., news that may not have a large impact on the platform, but it’s actually momentous.

Another great strategy is to hedge against existing global risks, such as political or economic affairs, which are highly unpredictable and volatile.

Finally, you can practice arbitrage across different platforms, exploiting differing prices for the same markets and outcomes.

How Prediction Market Earnings Are Taxed

Prediction market earnings are taxed either through Form 1099-B for tax reporting or under the Section 1256 60/40 rule, which treats 60% as long-term capital gains and 40% as short-term capital gains, regardless of the holding period.

Also, in some states or regions, gains from prediction markets may be treated as gambling income.

To pay taxes on gambling income and keep records of prediction market winnings in general, we highly recommend that you consult a tax professional.

Why Financial Advisors Say It Isn’t Investing

Prediction markets are often considered not investing by many financial advisors because they don’t build equity, pay dividends, or track broader economic growth.

In fact, they are more speculative in nature, treated as vehicles or hedging tools rather than for long-term investing. Also, some types of investing (e.g., passive investing) bear low to no risk, and prediction markets do carry risk, because users can and do lose money.

List of Prediction Markets & Examples

Where people trade dictates what they trade. In the domestic market, legal US platforms like Kalshi, Robinhood, and ForecastEx pair directly with real-world contract examples:

• Politics: Trading specific election outcomes, like Which party wins the House in the 2026 midterms.
• Macroeconomics: Speculating on financial policy shifts, such as upcoming Fed rate cuts.
• Tech/Current Events: Betting on operational milestones, like US government shutdown timelines.

However, when exploring the wider list of prediction markets and global prediction markets examples, we prioritize the Polymarket Vs Kalshi matchup, recommending Polymarket above all for its superior volume.

The Risks of Prediction Markets - What You Need to Know

There are a couple of notable things you need to understand about prediction markets to protect your trading capital. It’s not hard to grasp; it’s just that some inexperienced players aren’t aware of the facts we’re about to present, and it may affect their trading capital in some instances.

Shifting Laws and Platform Rule Changes

The law may change, and the platform you use may stop operating in your region. This may result in no place to have fun and, potentially, no funds held at the time of closure, which you may later have to recover through legal disputes.

Furthermore, you should be aware of the platform’s rules, especially regarding event resolution and edge cases such as event delays. Some platforms have rules that always work in their favor, so be sure to scrutinize them before trading.

Capital Management and Trading Discipline

On prediction market platforms, markets are available and running 24/7, which may be engrossing for some users. Also, users can become emotional and trade in fits of passion or anger, rather than making rational decisions.

We advise you to avoid this and treat trading as a side activity, never as a way to make an income. Plus, we suggest creating a strict bankroll and using position sizing, as in stock or forex trading, to help protect your capital.

Insider Trading and Ethical Concerns

Some low-liquidity markets may be suspect, because some traders may have insight into changes before you and can use that opportunity to buy or sell contracts before or after you (whichever makes them a profit).

This is why you should mitigate the risk by trading in highly liquid, high-volume markets (such as those around major political or economic events) where public information is abundant and pricing is highly efficient.

Prediction Markets and Sports - What Football Fans Should Know

Trading itself is different from sports betting. The biggest distinction is that you can predict macro events (e.g., whether the Seattle Seahawks will win the Super Bowl) rather than small player props available on betting sites. This is different in that you need to focus on larger, more general events and outcomes rather than tiny details.

Also, on prediction markets, you can buy a contract before or during the match, but what’s special is that you can sell it at any time, regardless of price or league.

All in all, betting on prediction markets is a great alternative to traditional sports betting, especially if you live in a state where traditional wagering is prohibited.