A goat herder in Northern California recently did something more typical of a Wall Street investment bank: he hedged risk with derivatives. Tim Arrowsmith faced a sharp jump in labor costs after a state wage exemption policy expired on June 30. No insurer would cover the risk, and no futures contract existed for it. So he paid $50,000 for a contract on Kalshi that pays him $500,000 if Sacramento does not fix the rule by October 1. If Sacramento changes the policy, his labor costs remain unchanged and he loses only the $50,000. If the rule stays in place, he will have $500,000 to offset the higher labor costs.

Prediction markets, for the first time, are giving small businesses like Arrowsmith’s access to risk-management tools that Wall Street has relied on for years.

Until relatively recently, most Americans did not think much about derivatives markets. Yet those markets and instruments have allowed farmers, oil producers, financial conglomerates, and entire sectors of the economy to keep prices and costs more stable by transferring risk to someone willing to take it on. They also provide information about where risk is headed, helping people make better decisions. U.S. derivatives markets have helped create and sustain the greatest economy on earth.

The main reason is the structure of the Commodity Exchange Act (CEA), the law that governs those markets. It has produced the most innovative and broad set of derivative instruments in the world, traded on some of the most well-regulated markets anywhere. The CEA recognizes that anything that can create risk for people and businesses — whether a physical good, a financial concept, or an actual event — can serve as the underlying asset for a derivative listed on a federally regulated marketplace.

Although prediction markets have grown quickly only recently, event contracts are not new. They are another innovation within that framework, not a break from it. On a prediction market, event contracts pay out depending on whether something happens in the real world: who will win an election or the World Cup, whether there will be a recession, how many cars Tesla will deliver each quarter, and more.

Comparisons between financial trading and gambling are also nothing new. As long as markets have existed, critics have argued that they are merely places for “risky bets.” But trading on federally regulated derivatives markets is very different from gambling on roulette in a Las Vegas casino or allowing DraftKings to set the odds, cap winnings, and profit from losses. The venue, not the product alone, determines the proper regulatory treatment and how the activity should be characterized.

Prediction markets are financial exchanges, not bookmakers. Unlike a bookie that takes the other side of a wager and sets the odds, they act as intermediaries and do not favor one side of the trade. The market, not the exchange, sets the price, and traders can exit their position at any time, just as they can in a traditional financial market. Some products may appear to straddle both worlds, but what is behind the screen matters. Casinos and sportsbooks, which have every reason to feel threatened by a more transparent and fair model, have argued that these markets have no economic utility. They should speak for themselves.

The Arrowsmith hedge is only one example of what prediction markets can make possible. Event contracts now cover risks that no prior risk-management product reached, including environmental funds hedging California carbon allowance prices and ice cream shops hedging against a rainy summer. Businesses too small to attract the attention of a Wall Street desk can transfer a specific risk to someone willing to price it.

The value of these markets goes beyond the ability to trade them. They also generate information. Unlike social media posts, which optimize for attention and for “what you want to be true,” prediction markets optimize for accuracy and for “what will be true.” A recent Federal Reserve report found that Kalshi markets provide an accurate, real-time reading of the economy that is useful to researchers and policymakers, and even outperformed Fed funds futures in predicting interest-rate moves.

Yet because of the sports connection, many states have aligned with casino interests and tried to ban prediction markets or subject them to piecemeal state-level rules intended for roulette wheels rather than instruments designed for price discovery and risk management. States, driven by gaming interests, have sued prediction markets because they are worried about competition. New York, the capital of finance, is among them.

A regulatory model built around casino businesses — where the house sets the odds, ensures it wins, and profits directly from customer losses — is not suited to national markets that require uniform federal, exchange-focused rules to function. Imagine if a state could stop you from buying Tesla stock because its governor disliked Elon Musk. Or if you could buy a stock on the New York Stock Exchange only from traders in your own state. The stock exchange as we know it would cease to exist.

As a former CFTC commissioner, I have seen how valuable derivatives are for farmers, oil producers, and financial institutions seeking to insure against the risks of doing business. These markets also produce prices for things that no one else will price, which matters at a time when trust in many other sources of information is declining. Both of those functions are what the law governing derivatives, and its federal regulator, are meant to protect.

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