The Federal Government Is Suing Three States to Stop Them From Regulating Prediction Markets. Here's What's at Stake.

On April 2, 2026, the U.S. Commodity Futures Trading Commission and the Department of Justice filed federal lawsuits against Arizona, Connecticut, and Illinois — naming Governors Katie Hobbs, Ned Lamont, and JB Pritzker among the defendants — seeking to permanently block those states from enforcing their gambling laws against prediction market platforms [1][2]. The suits are the first the CFTC has ever filed to stop state gaming regulators from policing prediction market operators [3].

The legal question is stark: Are prediction markets — platforms where users buy and sell contracts pegged to real-world outcomes like elections, sports results, or economic data — regulated financial instruments under exclusive federal authority, or are they gambling operations subject to state law? The answer will shape the future of an industry that barely existed five years ago and now processes hundreds of billions of dollars annually.

The Lawsuits: What the Federal Government Is Claiming

The CFTC's legal theory rests on the Commodity Exchange Act (CEA), the federal statute that governs derivatives trading. The agency argues that prediction markets offer "event contracts" — a type of swap, or derivatives contract, in which people wager money on future events — and that Congress gave the CFTC exclusive jurisdiction over swaps traded on registered designated contract markets (DCMs) [2][4]. Because platforms like Kalshi operate as CFTC-registered DCMs, the agency contends, state gambling laws cannot reach them.

CFTC Chairman Michael Selig framed the stakes bluntly: "The CFTC will continue to safeguard its exclusive regulatory authority over these markets and defend market participants against overzealous state regulators" [1].

All three states had issued cease-and-desist orders to prediction market companies, accusing them of operating illegal gambling businesses [2]. But each state took a distinct enforcement path:

• Arizona went furthest. Attorney General Kris Mayes filed 20 criminal misdemeanor charges against Kalshi on March 18, 2026, alleging the platform accepted bets from Arizona residents on professional and college sports, individual player performance, and election outcomes — including the 2028 presidential race and the 2026 Arizona gubernatorial race [5][6]. Arizona law prohibits both operating an unlicensed wagering business and betting on elections outright [6].

• Illinois issued cease-and-desist letters through its gaming regulators, treating prediction market contracts as unlicensed gambling products. A spokesperson for Governor Pritzker responded to the federal suit by calling it evidence that "the Trump Administration is carrying water for companies driving well-documented and lucrative insider trading schemes" [4].

• Connecticut pursued enforcement through its Department of Consumer Protection, issuing cease-and-desist orders under state consumer protection and gambling statutes [2].

The federal suits ask courts to declare that CFTC rules preempt the challenged state laws and to permanently enjoin enforcement [1].

An Industry That Exploded Overnight

The prediction market industry has grown at a pace that few regulators anticipated. Annual trading volume rose from roughly $300 million in 2020 to $6 billion in 2024, then surged to $44 billion in 2025 [7]. Based on early 2026 monthly volumes — Kalshi and Polymarket combined for $17.9 billion in February alone — the industry is on track to exceed $200 billion in annualized volume this year [8][9].

Source: DeFi Rate / Gambling Insider

Data as of Apr 1, 2026CSV

Two platforms dominate. Polymarket recorded $56.07 billion in notional volume in 2025, while Kalshi posted $44.71 billion. Together, they account for roughly 97.5% of the market [10][11].

Source: DeFi Rate

Data as of Mar 1, 2026CSV

Sports contracts drive much of the growth: 85% of Kalshi's volume comes from sports-related event contracts [7]. Polymarket's activity is more diversified, with sports (39%), politics (34%), and crypto (18%) each contributing significant share [7]. This breakdown matters because sports-related contracts are what state gambling regulators view as most clearly within their jurisdiction.

The Preemption Battle: A Split Legal Landscape

The federal government's preemption argument faces a divided legal landscape. The CEA contains no express preemption clause regarding state gambling laws, which limits the CFTC's ability to claim Congress explicitly displaced state authority [12].

Kalshi's primary theory is "field preemption" — the argument that Congress granted the CFTC such comprehensive authority over DCM-traded contracts that no room remains for state regulation [12]. States counter with the narrower standard of "conflict preemption," arguing that federal law only displaces state authority where compliance with both is impossible or where state rules directly obstruct federal objectives [12].

Court rulings to date have gone both ways:

• A Nevada federal judge in March 2026 declined to block state enforcement, finding that the CEA "does not completely preempt" state gambling claims. A state court then issued a temporary restraining order barring Kalshi from offering contracts to Nevada residents [13][14].

• A New Jersey court granted Kalshi a preliminary injunction in April 2025, but the Third Circuit appeal remains pending [12].

• A Maryland court denied an injunction in August 2025, holding that Congress did not intend to displace state gambling authority [12].

• A Massachusetts state court in January 2026 ruled that Kalshi's contracts fall under state gaming laws, rejecting preemption arguments as "overly broad" [12].

A brief signed by 34 state attorneys general argued that "when Congress removes the States' historic police powers, it does not whisper in the dark of night" — contending that nothing in the CEA clearly signals Congress intended to strip states of their traditional power to regulate gambling [15].

Appeals are now pending in the Third, Fourth, and Ninth Circuits [12]. Most legal observers expect the question to reach the Supreme Court [12][15].

Follow the Money: Lobbying, Donations, and Political Connections

The prediction market industry has invested heavily in the political infrastructure needed to win the preemption fight. Kalshi spent at least $1 million on federal lobbying in 2025 — a record for the company — bringing its total federal advocacy spending since 2021 to $1.73 million [16]. Miller Strategies LLC received $510,000 of that total, followed by Capitol Counsel LLC at $400,000 and Lincoln Policy Group at $300,000 [16].

Kalshi CEO Tarek Mansour has personally contributed more than $120,000 to politicians or related groups since the start of 2025, according to FEC filings [17].

The company helped launch the Coalition for Prediction Markets in late 2025, with Robinhood, Coinbase, Crypto.com, and Underdog as co-members. The coalition is led by former Democratic Congressman Sean Patrick Maloney [17]. The bipartisan gloss is strategic: the CFTC's current posture aligns with the Trump administration's broader deregulatory agenda, and Donald Trump Jr. advises both Kalshi and Polymarket [3].

Todd Phillips, a law professor at Georgia State University, characterized the federal suits as "trying to put a thumb on the scale" rather than merely expressing a regulatory view [3]. Amanda Fischer of the nonprofit Better Markets described the industry's approach as mirroring cryptocurrency companies' strategy: "operating with intentional legal risk while building customer bases until law is bent to fit their business model" [3].

What States Stand to Lose

The financial stakes for states are substantial. The American Gaming Association estimates that states have collectively lost more than $600 million in tax revenue from wagers placed on prediction markets that operate outside state gaming frameworks [18]. Unlike licensed sportsbooks such as DraftKings or FanDuel, prediction market platforms registered with the CFTC pay no state gaming taxes.

Source: MultiState / Holland & Knight

Data as of Apr 2, 2026CSV

Eleven states have issued cease-and-desist orders or taken enforcement action against prediction market operators [18]. At least eleven more have introduced legislation in 2026, with approaches ranging from outright bans to taxation frameworks [18]:

• Hawaii passed legislation (HB 2198) expanding its definition of gambling to include prediction markets [18].
• Kentucky enacted a 17.25% tax on prediction market operator transaction fees (HB 757) [18].
• Tennessee introduced bills that would criminalize conduct aimed at influencing event outcomes for personal prediction market benefit [18].
• California held hearings on a bill (AB 1840) restricting prediction market transactions by public officials who possess material nonpublic information [18].

If the CFTC prevails in the three new suits, these state-level efforts could be rendered moot.

The Historical Backdrop: How the CFTC Got Here

The CFTC's relationship with prediction markets has shifted dramatically over three decades. The agency first allowed event contracts in 1992, granting the University of Iowa's Iowa Electronic Markets a no-action letter to operate academic election prediction markets [19].

The terrain changed in 2012, when the CFTC prohibited the North American Derivatives Exchange from listing political event contracts, ruling they involved "gaming" and were "contrary to the public interest" [19]. For the next decade, the agency maintained a cautious posture, and platforms like PredictIt operated under narrow no-action letters limiting participation to 5,000 traders per contract [19].

The inflection point came in 2024. Kalshi sued the CFTC itself after the agency blocked its Congressional election contracts. A federal appeals court ruled in Kalshi's favor, finding the CFTC had overstepped [19][20]. Following the November 2024 presidential election — during which prediction markets attracted widespread public attention — the industry's volume and user base grew exponentially [7].

Under the Trump administration, the CFTC reversed course. Chairman Michael Selig formally withdrew the Biden-era proposed rules that would have restricted event contracts, explaining in February 2026 that market developments had rendered the rules unnecessary [20]. On March 12, 2026, the CFTC issued an Advanced Notice of Proposed Rulemaking signaling a more permissive framework [20]. Three weeks later, the agency sued three states.

The Case for State Authority

States and their defenders argue that the CFTC's jurisdictional claim is historically unprecedented and constitutionally suspect. The regulation of gambling has been a core state police power since the founding era, and the Supreme Court's 2018 decision in Murphy v. NCAA — which struck down the federal Professional and Amateur Sports Protection Act — reaffirmed that states have primary authority over sports wagering [15].

The 34-attorney-general brief made a textual argument: the CEA was designed to regulate commodity futures and derivatives, not to authorize a new category of consumer gambling products [15]. Several courts have been skeptical that the desire for nationwide regulatory uniformity alone satisfies federal preemption standards, particularly where states' long-recognized police powers are at stake [12].

Professor Phillips noted that the products at issue — contracts on who will win a football game or a gubernatorial race — bear little resemblance to the agricultural and financial derivatives Congress had in mind when it enacted the CEA [3].

Second-Order Risks: Manipulation, Foreign Capital, and Disclosure Gaps

If federal preemption succeeds and states lose regulatory authority, several downstream risks come into sharper focus.

Insider trading. Federal prosecutors were already exploring in March 2026 whether prediction market bets violate insider trading laws [21]. In February 2026, at least two individuals were indicted for allegedly using classified national security intelligence to place wagers on Polymarket, reportedly reaping as much as $100,000 in profits [22].

Market manipulation. The Atlantic Council flagged prediction markets as "dual-use infrastructures" vulnerable to foreign influence operations [23]. Because many markets are thinly traded, a single six-figure trade can meaningfully shift prices. Coordinated networks can then cite the shifted price as an "apparently neutral indicator," turning a small financial outlay into a tool for shaping news coverage and public expectations [23].

Foreign capital. Polymarket's most controversial markets — including those involving Venezuela and Iran — operate on its offshore site, outside U.S. federal regulation [22]. No current federal framework requires disclosure of foreign capital flows into election-related prediction contracts. Members of Congress have raised concerns: in March 2026, lawmakers from both parties questioned whether existing congressional ethics and disclosure rules cover prediction market positions [24].

Campaign finance implications. Representative Jamie Raskin and Senator Jeff Merkley introduced legislation that would ban prediction market gambling on elections, sports, war, and government activity, arguing that such markets "undermine public trust and invite corruption" by allowing bad actors to "manipulate government actions to their own advantage" [25].

What Happens Next

The three federal suits filed April 2 will proceed through district courts while related appeals move through the Third, Fourth, and Ninth Circuits. Arizona's criminal prosecution of Kalshi adds a parallel track in state court. A Nevada state court has already issued a temporary restraining order against Kalshi, setting up yet another potential appellate dispute [14].

The CFTC's Advanced Notice of Proposed Rulemaking, issued March 12, signals the agency intends to formalize its regulatory framework for prediction markets — a process that could take months or years [20]. In the meantime, at least eleven state legislatures are moving forward with their own bills [18].

The most likely resolution is a Supreme Court ruling. The circuit split is widening, the stakes are measured in hundreds of billions of dollars, and the underlying question — whether a federal commodities regulator can shield a consumer gambling-like product from state oversight — touches fundamental principles of federalism. Until that ruling comes, prediction market platforms, state regulators, and the millions of users placing bets will operate in a patchwork of contradictory legal rules.