The CFTC’s Vision for Prediction Markets with Dorothy DeWitt | Prediction Market Movers

[MUSIC] Welcome to Prediction Market Movers. I'm Chris Gerlocker with Prediction News, and we have Dorothy DeWitt here today. Not only does she have her own consultant firm within the commodities and Prediction Market space, but she also led the team that designated Kalshi as a DCM back in the day when they applied and finally got the license. So this is a big CFTC episode, and I've been excited to do this since we did the pre-call and talked about what we're going to discuss today. This is going to be a great inside look at the CFTC during the early Kalshi years and today through fam and ceiling as well. So lots of really good questions to cover today. The other great questions we're grappling with over Prediction News are who is going to win the 2026 midterms. You don't want to wait all the way until November to figure out who's going to win. You want to get a pretty good idea of what's going to happen now. Well, Prediction Edge covers all the election data that really matters. You've got your real-time Prediction Market odds alongside your fundraising data, your polling, your candidate profiles. All pulled together into data that you can have emailed straight to your inbox. You've also got your polls versus market section. So you can see where the polls and markets tell you different stories. And we've got the calendar so you can see which trades are coming up next. So head over to PredictionEdge.com and give that data a look. Now Dorothy, I want to go all the way back to the beginning of Kalshi. You're in your office at the CFTC. What is the original pitch for this company that crosses your desk? So Terkin Luan came in and said we want to be the first fully registered, fully committed to PredictionMarket Exchange. There have been prediction markets in the past and most have been exempt from registration or given relief from registration with some conditions or limited in scope or extent or volume and other things like that. And they wanted to be the first that was registered and dedicated and interestingly a disintermediate model. In the past at the CFTC you had a DCM which is an exchange and you had customers like Delta Airlines wanting to hedge its fuel cost or producers and other hedge funds that are speculating and other things. And they were generally introduced to the exchange for purposes of trading by an intermediary. We call it an FCM. It's effectively a broker dealer and the members of the exchange were these FCMs. And this type of exchange that Kalshi asked to do is a disintermediated exchange where the members of the exchange are you and me and maybe a hedge fund and maybe some other stuff. But generally back then it was all retail and that's a different model. We've had that before to a limited degree but this was intended to be all prediction markets, all disintermediated with members of the exchange like you and me and that was different. It listing different contracts and anything we had considered before. What kind of obstacles or concerns did Kalshi have to overcome to convince the CFTC to designate them as a DCM? Sure. If I recall this is about they applied in about 2019 and they worked with my team for the better part of a year to get everything in place and make sure that everything was conforming with the requirements and core principles that DCMs have to comply with. The real fireworks came when they were designated and they started self-certifying event contracts. And the reason why I called it fireworks is there are several requirements for contracts. One is that they're not readily susceptible to manipulation, that they have clear data, references and resolution criteria and a whole bunch of other things. And to be honest our product team, which is a bunch of economists, had a real hard time kind of getting their arms around this really broad array of self-sort of event contracts from the very beginning. And that caused some hiccups and they would just say, I don't know, it's a B population readily susceptible in manipulation or anything because these were all very different contracts or any of these readily susceptible to manipulation. They also listed contracts on whether, for example, the IRS would take up an approach this way or that way, your tax rates would change and things like that. And I remember having to call up the Treasury Department and say, "You may not know what these prediction markets are, but their prediction markets on what you're doing." And they said, "Well, we don't really love that." And I said, "I understand, but that's law and regulation. They can do this and they're going to do this." So just wanted to give you a heads up, things like that. And you know, there were some ups and downs on our end. And there were a few on their end that we all kind of all worked out. And you know, here they are. Once you get past that first year in operation, once we're past 2020, it's the second year. There's more of a relationship there. There's also a new administration. What is the approach to prediction market in the early Biden years aside from the election contract case that is going to be well known by this audience? Yes, so what we discovered in 2020, and this is under the early Biden administration, is that the commodities exchange act in relation to event contracts did not match the rule promulgated by the CFTC implementing that statue. They were just different. And I can explain why if you want. And that was a real challenge, like how do we address this? We don't think that the rule was intended at all to be inconsistent, but you know, mistakes happen in rulemaking all the time. This rule had been implemented in about 2011 or 2012. And the act says that if there are certain types of contracts, gaming, or terrorism, things that are against state or federal law and things like that, the CFTC may conduct a public interest review. And if it decides that after conducting that review that it's against the public interest, then it can stay that contract. Don't know what the criteria for public interest review. The rule itself says, the act, I'm sorry, the act suggests that it's contract by contract review, but the rule itself that was promulgated in 2011 or 2012 says categorically, on a categorical basis, those enumerated contracts, war, terrorism, gaming, et cetera, et cetera, are banned. And it's not clear that a public interest review is performed, and it's on a category, not a contract by contract basis, et cetera. And so they didn't match. When the public interest review happens and how and whether it's categorical or by contract, so they didn't match. So what are we going to do? And we didn't fix or change that rule, and it hasn't been fixed or changed since. There was a proposal under later-bitered administration to make some changes, but that didn't take effect. And the CFTC later lost in district court and early, early action in the appeals court before the CFTC withdrew it under the new administration. So there's some new rule making that's trying to reconcile the rule and the act, which is good. Good on the CFTC. We'll get into guard rails in a few minutes. I want to hover a little bit on 2025 and 2026, where you have Acting Director Carolyn Femme, and now we've got Mike Steeleg in his chairmanship. What are the main differences between these two people, who a lot of people may see as one continuous mass of tenure? It's a great question. I don't see them as different in direction. I see them more as sequential and consistent. So Carolyn Femme was the acting chairperson at the CFTC. She was a chair who was Republican and she had to, during a change of administration, the minority party folks contend to resign and so can the majority if they don't get the chairmanship. And so she had at 1.2 Democrats in herself, so it's hard to get an affirmative vote on, for example, an enforcement action, et cetera, that is maybe consistent with the sprint that Carolyn Femme wanted to do. But eventually, everyone laughed and she became the only chairperson at the CFTC, which was the first. And you can get a lot more done if you're the single chairperson. You could also be, you know, everything you do is also subject to litigation risk because you're doing it as a single chairperson. So she did a lot of work avoiding or remediating what she saw as a regulation by enforcement. She upended the enforcement department and got rid of a lot of senior enforcement folks. She also pursued crypto and prediction market friendly policies. And it's hard to know how much direction she had from the administration, the administration had Giancarlo and Atkins and Tarbert, former Republican chair people to make sure that they understood kind of the key issues. And I think the administration and the CFTC are working fairly seamlessly, it appears by census, they're working fairly seamlessly together to implement the administration's priorities. And as you can see from chats and you know gatherings in the White House of those who own companies that offer prediction markets, the administration is very favorable to the industry. What about Mike Ceeleg, what is his apparent priorities ban as we've seen him in the chair for almost a year now? Yes, so his priorities have been fairly consistent in that he said early on we want to ensure perpetuals and we want to allow for real perpetuals to trade. And he's done that. He has also said you know we want clarity as to who has drag who has a jurisdiction of what SEC and CFTC. We want to have harmonization between the SEC and CFTC and they have done that. That's always been a challenge. I knew of myself, I worked very well with the my counterparts at the SEC and there were times that you know we didn't see eye to eye and the commission didn't see eye to eye. But I think they have been working very hard to have harmonization and coming up with some creative ideas like if you need to be registered with the CFTC and the SEC historically you'd be it just to be two different processes. You'd be examined by both. You're kind of facing off to do two different regulators. The SEC is much more prescriptive. The CFTC has its principles based so it's a little it's more flexible in some ways that you can comply with all the requirements and that can be very hard. And so I think the CFTC and the SEC have come up with some are working on coming up with some very creative solutions of like a primary regulator to secondary regulator. You know there may be some litigation challenges around that to make sure that those you know those structures are consistent with the act with the act. But anytime you have a unitary commissioner just one commissioner instead of five which is very very typical having five. You you you're a little bit more subject to litigation challenge. And you can see that the CME soon this CFTC on perpetuals. How might the legal landscape change if the next administration regardless of party Republican or Democrat takes a look at the single chair model and says well let's do a chair of my party plus two more of my party no more minority party. How want to how possible is it into how might the the legal threat or legal risk change in that scenario? Yeah so two things have changed since the norm in the last administration of five commissioners and prior to that. The first is that the Supreme Court said that the president can fire commissioners it will as opposed to for cause. And so as a result it's harder to get minority commissioners to agree to the job. They're paid crazy low amounts the commissioners and they could move to DC and get fired anytime right. So you know part of why you don't have Democratic commissioners maybe because maybe in part because it's it's hard to find folks with experience. I think that's a real it's too bad but the second thing is that norms have been so the Supreme Court's rule the second thing is that norms have changed and so those norms reflect that there's a unitary commissioner and etc. I think at a minimum the next administration would have let's say if it's the same administration or same party is probably going to stay consistent. If it's a different one like a Democrat administration I think in a minimum they would have a chairman and two Democrat commissioners so you have three instead of one and that sort of mitigates a little bit the some of the litigation vulnerability but you know I don't know whether they'll 0.5 and I don't you know it's hard to know like we're living in a charter territory. Sure let me well I'll take us back into a charter territory then and ask you about some of the guardrails that are beginning to go on the prediction market industry so I know CELIG has implemented some rulemaking and we're beginning to see restrictions and concerns become a little more obvious from the CFTC what kinds of guardrails are beginning to be put on this nice young industry? Absolutely so first there's been a pause in some mentioned markets for example Kalshi agreed to a pause in mentioned markets and sports based on some real concerns in the industry and the and the commission. Polymarket US doesn't currently have mentioned markets and the FCM some of the FCMs are not allowing their customers Robin Hood for example doesn't allow its customers to trade mentioned markets. I think mentioned markets in my own view as a former regulator that ran the group that reviewed application and self-sortifications and whether things were readily susceptible to manipulation. I have always thought mentioned markets are maybe inconsistent with core principle 3 which is you can't know exchange whether it's prediction or traditional contracts like oil or gas. No exchange can list a contract that's readily susceptible to manipulation and they have to do a big analysis on that among other analyses they get submitted with a self-sortification and the CFTC just came out with a kind of advisory or guidance saying you got to put more information into your self-sortification. You don't see you and I don't see all that information because it's it's redacted for FOIA protection but the CFTC does and it's clearly signaling it's not getting enough information for them to evaluate whether the self-sortified contracts are consistent with regulations and core principles and such. So I think that I really laud the CFTC for that. They've also done some guidance by staff on incentive programs and that that will be helpful as well. They basically have said you know you have to if you're going to change your rule book DCMs have rule books are usually like 100 pages and they include all kinds of things like how you're going to be did you know how discipline works and how trading works and how incentive programs work and affiliated market makers you know the market makers and how they address the incentive programs and things like that. And so DCMs have been filing rules in that rule book or rule of changes around incentive programs that the CFTC has recently communicated our insufficient or non-compliant with their obligations and they've given some guidance on how to do that better. There's some other current industry issues that have become a little more if not contentious at least that have gotten more attention. I want to turn to those. Why is vertical integration one of these increasingly hot topics in the industry right now? Yeah it's funny it's like with anything you know when we designated CalChi in 2020 they were doing a lot of new types of contracts but it really took to 2025 for it to be headline news and all the issues that we were adjusting in at first impression or issues that are at issue in litigation and other things and the same thing with vertical integration. Vertical integration has been an issue for 10 years or more. So vertical integration means an exchange which is a DCM, an intermediary like Robert Dela which is an FCM and a clearinghouse which is a DCO. And vertical integration is where you have kind of all three affiliated in one as sub's and one entity they're all three affiliated and you might even introduce a fourth affiliate which is an affiliated market maker. And vertical integration really poses some significant conflicts of interest that have to be addressed. So for example if the FCM is a member of the exchange and an intermediated or hybrid model and it's affiliated there will likely also be other FCMs on the exchange and so does that FCM have access to additional information which is conflicts of interest information barriers. If the exchange goes down or there's some problem with the FCM or some problem with the affiliated FCM or the affiliated FCM's customers are they going to be treated the same or differently than all the other FCMs that are on the platform. There are lots of incentives conflict of interest incentives in vertical integration that have been addressed and been the subject of concern by the commission for over a decade. But I think what's happening now is if there's a more of a willingness to designate all three plus an affiliated market maker. And so you're it's not just a theoretical concern it's a it's a reality and so that's why I think it's getting more recent attention. What are some of the proposed solutions to the conflicts of interest that accompany vertical integration. Yes, we help our clients on this all the time. So you want to make sure your rulebook that that long document is very clear on how your members are going to be treated and conflicts of interest. They're going to be addressed. There's a core principle that's specific to conflicts of interest. You need to basically identify all the conflicts of interest in your model and then you need to go through one by one and figure out how to mitigate or solve those conflicts of interest. You basically make a kind of matrix of conflicts and then you integrate policies and procedures and information barriers and other types of things like other types of things that are operating in the exchange to make sure that everyone is being treated equally. And then when there is a problem, you need to make sure that everyone is treated equally and that needs to be really well documented. And because otherwise you'll get complaints from the other FCMs or from customers and things like that. And those complaints will go to the CFTC and the CFTC will take them very seriously. And I law the commission for taking these conflicts of interest issues very seriously and as they should be. And I law our clients for also doing that. There are not perfect but very good kind of solutions or mitigants to most all of them and really the proofs in the putting. It's one thing to have a policy to treat everyone equally and how the procedures is to what that means and how you operationalize that. It's another thing to actually do it in the middle of an issue. And so those are things you need to think through and we work with clients on that at the time. One of the other big issues is not only 24/7 trading but now perps as well. Why is this structure of a contract so disruptive for the CFTC? It's a change in a few different ways. The CFTC has considered perpetuals to be over the years, to be swaps or futures or futures or swaps. And different share people and different commissions can change their interpretation consistent with kind of their remit. As long as those interpretations are reasonable, it's a little more challenging when they're kind of diametrically opposed. And you know, we're kind of skirting the border there. Up until very recently, these perps were considered swaps and the current chair has been very clear that he believes that they are futures. Futures usually expire. Like you have a futures and oil that expires in a month and another one that expires in a month later and another one that expires in a month later and you have to roll. So if you have a hedging position that expires this month, you have to roll to the one that expires the next month or further out in the future, etc. In futures are kind of, by definition, they expire and either cash has exchanged physical delivery on a future date. Perpetuals don't have expiration. They go on forever in perpetuity and they weigh that they are, you need to have alignment between the spot market and the futures market at expiration traditionally. And when you don't have that, it's a mess. The way that alignment is created in the real perpetuals market under the CFTC and elsewhere is an exchange of payments that incentivizes the futures price to be consistent with the spot price. There are some benefits to futures. For example, if you have a prediction market or something like that, you have a bunch of people piled into a market and then the event happens and then all the liquidity goes away. And so there's a desire to institutionalize prediction markets and perpetuals can help doing that because you have continuous funding and you have continuous liquidity. You don't have cliff expirations where liquidity goes away and you help liquidity will come back for the next event or next month and things like that. So, perpetuals are important for institutionalizing and bringing in liquidity. But, you know, it's a little bit touchy as to how their categorized and their use case and that's why CME soon, the CFTC saying, "perpetuals are not futures." The other part about perpetuals is if they're on things that are traded on the spot, the exchanges that do spot are probably going to lose some of their volume because it would be just as easy to get the equivalent of a spot positioned in a perpetual future without putting up as much money because you've got some leverage and things like that. So it's a real business model challenge. Talk me through why from the CFTC's perspective, the regulatory difference between swaps and futures is so important for confronting some of these questions. Well, I'll just give you two examples. First of all, they're just treated differently under the law and the regulation, the quantity exchange act and the regulations and they have different swaps. For something to be designated as a swap, there's a lot more regulatory requirements for trading. There's a very onerous swap data reporting mechanism and some other things like that. So swaps can be a little bit onerous, but swaps are the only avenue for prediction markets to have potentially the ability to trade nationwide and to Trump state law in sports and a couple of other areas. So you're kind of pushing the swap definition for certain prediction markets and you're pushing the futures definition for perpetuals. And you know, sometimes those can be often those can be consistent. There can be some inconsistencies. Futures are more easily traded in the sort of operational and reporting and other mechanisms around futures are a little bit simpler. So, you know, one wouldn't be wrong to wonder if those, you know, pushing into each of those definitions, each of those products is related to a desired outcome and the key is whether there's consistency in the law and the roles and the application. One of the other interesting issues that I haven't seen discussed very much in this space is arbitration and customer disputes. How am I the handling of those issues change in a mature prediction market industry? Yes, I've been thinking about that a lot. So, most prediction market bets are pretty small. And, you know, if you think back 20 years ago, exchanges, if there were issues on exchanges, it was like some huge contract by Delta and Fuel Oil, like those were big denominations, right? And arbitrating something with a big denomination versus something with a $10, $20, $200 denomination, or notional, I mean, is that they're very different. And so, anything related to a broker dealer, the SRO for the industry in FA does the arbitration on that, but for prediction markets, if I disagree with the outcome, say there's an ambiguous outcome and there's a decision, I'm just using an example by Kowshi. Kowshi, let me just back up a little bit before I go there. Under the law and statute, the exchanges can require arbitration for disputes. And those are in all the member agreements. And so, generally, everything is arbitrated. But, let's go through the process. There's some event that happened this morning. I didn't agree with the resolution. I had, you know, money that was meaningful to me at stake, or maybe $10, you know, it doesn't even matter. And so, Kowshi gives a fairly narrow window to file a kind of complaint, and they have an outcome resolution committee that looks at that. And they generally will have the outcome resolution committee review it, and then, you know, they may settle to make me whole, or they may have, or whatever it tends to be. If they don't, and I'm still unhappy, I can ask for arbitration. And it's one thing, if it's a huge number, it's another thing that's smaller number. And so, there's some real creative solutions out there for arbitration, like I know the American Arbitration Association has an AI product that supports very small stakes, as well as supports more cost efficient, large stake arbitrations. And I think those types of models can be really useful, like AI, with very limited, could, you know, decide very small disputes very cost effectively. And I can see there being some development in that area. Probably some new regulations as well, even for the smaller resolution sizes, I imagine. I don't know about new regulations. I think that, I think the market will bear with the market will bear. If they are really unhappy, they can file a whistleblower complaint. And, you know, that can be part of the investigation, because maybe they violated their rulebook, or something like that. But I think there's going to be, there's a future in small stakes arbitration in this industry, and probably big stakes, too. Well, it's going to be a fascinating area of the industry to watch grow. The other one, and this one I've seen a lot of headlines about, but I always feel short on detail. is the SEC/CFTC harmonization efforts. What is important and interesting there, and how many of the announcements and press releases can I ignore until, well, I'll let you go ahead and take that. I'm rambling now. >> My guess is you'll see product listing approval that has securities and commodity attributes, like maybe some of them are securities based swaps and summer commodities, and that will be a approval or some relief or something like that from the CFTC and the SEC that will simplify the ability to list these things with either simplified registration with the SEC and the CFTC being the main regulator or the other way around. I will say this. So there was a Innovation Advisory Committee meeting last week, and that's like, the CFTC has like five committees, and they're kind of, they're important, but they don't really get a lot of visibility outside the industry. So like an agriculture committee and market risk and things like that, and they've been around forever, and usually one commissioner or their five commissioners, one commissioner overseas each, one of each. There's a new committee that's called the Innovation Advisory Committee, and there's only one commissioner, so he's overseeing all the committees. And there are 35 members, and they're, you know, like Brian Armstrong and, you know, Vlad and the Winkleby twins, and other, you know, really big, big stakes crack in and other, other big stakes members, and they all convened last week. Never, I believe, in the history of these committees, has it not been open to the public. Like you can just walk in and listen to the committee, you know, but I imagine because the security risk bringing together all this CEO is just a significant, it was only available online. Anyway, long story short, there were some fireworks a little bit, in the CBOE, CBO really raised a very critical issue. CBOE has, is listing under its SEC registration, KPIs for companies. I don't know, like we'll test love, you know, these manufacturing numbers are some specific stuff. And they call them KPIs. Calci has been listing KPIs, the kind of similar stuff for a few years now. Now, regardless of what CBOE thinks or Calci thinks, there is a very colorable argument under security's law that if an exchange lists an unregistered security that hasn't had a, you know, and that hasn't been registered, there is a rescission right by anyone who loses money against the exchange. And I've been thinking about that for several years now. There are, you know, some of the prediction markets are listing KPIs. And in the past, when I was a DIMO director, this, I worked with my counterpart, the SEC, and they took the position without that compunction that a KPI like that is a security-based swap. And they have to, and an exchange has to be registered with the SEC. The P issue is not what the SEC is going to do about it, although that's important. The key issue is that a, in civil court, I, losing money on a KPI trade, can sue an exchange on KPI. And the judge may determine that that is an unregistered security, regardless of the SEC's input. And then I have a rescission right. And that could be like class action kind of stuff. So I think that's a real key issue that we're going to have to watch very carefully. Atkins said a few months ago that he's very focused on prediction markets. But I think they'll come out with something publicly that may address that. And that may be the harmonization. Where does taxonomy fit into this conversation? Oh, taxonomy is my favorite topic. We have on our team two people who developed taxonomies for the CFDC and the SEC for swaps. And that's a very big project. And we are developing a taxonomy that the industry can use. In the last week's meeting, the industry said, we don't want a taxonomy because it'll be a snapshot in time. And we won't be able to innovate with flexibility. I actually disagree with that. A taxonomy is absolutely critical for market growth and for regulation and for surveillance. Every asset class, like securities and swaps, and even crypto recently has a taxonomy. And the taxonomy is sort of breaking these contracts down into different categories and some categories, et cetera. It's important for industry growth, because a hedge fund will say, gee, I really want to put on a hedge for this type of risk, right? But there's not a lot of exposure. I mean, there's not a lot of liquidity there. And so with a taxonomy, they can look at correlation. And they can say, well, this other contract what seems unrelated is really highly correlated. So there's a lot of liquidity there I can put on a hedge. So it's really important to be able to attract institutional trading and other things to have a taxonomy. It's also important for regulation and surveillance, et cetera. If you have kind of identifiers in a taxonomy for each type of contract, you can do a lot more in preventing, detecting, and mitigating insider trading and other market abuse or manipulation, et cetera, et cetera. So I think a taxonomy is a gift to the exchanges who are under pressure to identify these issues, like as to the exchanges, because more liquidity comes in with a taxonomy and a gift to the CFTC, because they're able to also surveil and enforce with a taxonomy much better. And it just is a sign of a mature market. So we have been working kind of offline to use our expertise to develop an open-source taxonomy that may be of use to the industry. I know a lot of reporters will be looking forward to seeing it as well. And Dorothy has been so good to have you on and get all this explained to us. Where can we follow you, keep up with your work? Oh, thanks for asking. So I'm on LinkedIn, I'm on X, and so it's told strategies. And then, of course, we have our website, which is toldstrategies.com. Very easy to find. Well, you know where to find her and told strategies. Here's where you find us. Follow us on X over at Prediction Edge. And subscribe to our YouTube channel right here at Prediction News. And while you're here, give this video a like. It's a great way to support the channel. We always appreciate the support. Dorothy, thanks again for coming on. Thank you.