Data Boiler submitted further comments to the CFTC regarding Prediction Markets - Public Interest Determinations and Data Reporting Requirement for certain Event Contracts. Please see below for an Executive Summary:
The What and How of regulating Prediction Markets
Favorite-longshot bias is the core problem in Prediction Markets that harms retail investors per the empirical Whelan Paper. The “Volume versus Integrity Paradox” have too much friction. It starves out the “healthy” speculators. There is a lack of arbitrageurs to engage in price improvement to reduce the “stupid tax” or “overpriced lottery ticket effect” due to the market operator’s high fee-to-contract-value ratio. As long as regulators tolerate market structures that prioritize flow capture over actual market integrity, retail investors will continue to suffer from systemic exploitation. So, after the Commission finalizes the definition of what is traded, more emphasis should focus on how trades are executed.
The proposed review process, if adopted as-is, is insufficient or blind to data architecture and contract mechanics problems. It allows vertically integrated retail platforms to secure an exchange designation (DCM) or clearing license (DCO) to list event contracts while running a closed corporate loop. Vertical integrated platforms exploit their economies of scale to gamify execution, using a “False-Beard” veneer of retail democratization to drive unhedged momentum upstream.
Our recommendations: A Framework for Market Efficiency and Market Integrity
1. Definition of Gaming
We applaud the Commission for drawing the line and providing many examples in the proposal, in an attempt to delineate permissible versus prohibited event contracts applicable to Enumerated Activities. We concur with the proposal’s footnote 203 the Commission’s statement about “the coherent reading is the one the ordinary meaning of the word naturally supplies: gaming is the game itself — the activity in which occurrences, the extent of occurrences, or contingencies determine settlement.”
We suggest the use of powers of two logic (binary search) to serve as a practical litmus test. It creates an objective regulatory safe harbor by replacing vague, case-by-case “public interest” debates with a deterministic test rooted in computational intricacy, the CFTC can immediately filter out recreational games that rely on artificial friction and prolonged suspense. It is well fitted for the §40.11 (b)(2) [Reserved] provision to supplement the definition under the proposed §40.11 (b)(1). The litmus test implementation cost for DCM/ SEF is negligible, while the benefit for market participants is tremendous. This framework ensures that all listed contracts maintain high information velocity and strict commercial utility, protecting the integrity of the derivatives ecosystem while granting innovators a predictable, legally insulated path to launch novel hedging instruments.
2. Public Interest Factors applicable to Enumerated Activities
We strongly object to the Commission’s designation of contracts settling on “pre-collegiate level” or certain “collegiate level” outcomes as “negative public interest factors”; do NOT undermine the measurable achievements of young American leaders. Whilst, the “Presence of Prediction Laundering” (platforms that offload fact-checking to pseudonymous users while capturing commercial fees without legal recourse) should be added to the list of negative public interest factors.
Also, News ingestion must be banned in prediction markets because it relies on biased, addictive central curation that replaces active critical thinking with passive consumption, fuels extreme polarization, destroys public trust, and acts as a manipulative business tactic that ruins market neutrality.
3. Market Monitoring Metrics (Section 40.11 & Part 16)
- Adopt the Whelan Approach: Utilize the empirical Whelan Paper approach annually to calculate trading frictions and clear out the favorite-longshot biases that systematically exploit retail traders.
- Shift Insider Tracking to FCMs: Transfer the obligation to collect employee and occupation data from exchanges (DCMs/SEFs) to Futures Commission Merchants to prevent cybersecurity honeypots.
- Leverage DCOs for Migration: Mandate that Derivatives Clearing Organizations act as the back-end validators to track macro-level asset flights to offshore platforms.
- Audit Event-Adjacent Incident Referrals: Incorporate multi-tiered surveillance metrics from third-party monitors and sports leagues to track and log real-world match-fixing, DDoS infrastructure sabotage, and oracle tampering.
- Submit Narrow-Outcome Influence Scores: Require exchanges to provide mathematical risk scores mapping out exactly how easily an insider or a small group of decision-makers can manipulate a niche contract.
4. Operational and Technological Safeguards
- Mandate Cooling-Off Windows: Establish a 2-to-24-hour buffer window for contested inputs before distributing payouts to keep settlements anchored to verified facts.
- Deploy Supervisory AI: Proactively integrate machine learning and automated text-analytics to parse self-certified filings, flag ambiguities, and group similar contracts to assist the DMO review.
- Enforce Algorithmic Risk Simulations: Require platforms to programmatically prove their routing architectures naturally prevent spread widening, oracle manipulation, and front-running by preferred market makers.
5. Friction Test and Market Integrity
An empirical friction test evaluates market integrity by measuring how structural barriers, such as high fees and wide spreads, exploit retail participants and induce a favorite-longshot bias. By analyzing these metrics, regulators can identify when platforms transition from neutral utilities to predatory systems where liquidity providers extract risk-free rents, thus compromising true market integrity. To mitigate vertical integration risks (e.g., asymmetric info, liquidity circulation trap), the CFTC should enforce strict arm's-length separation between an exchange venue, guarantor, and brokerage arm to prevent platforms from using a "False-Beard" retail democratization veneer to generate hidden, toxic leverage loops. Lastly, vertical integration and the overuse of leverage could be a danger to the health of financial markets if the market for a “cause” may become an outsized risk in itself. We propose establishing a cross-market surveillance network.
Disintermediation Trap and Hidden Systemic Risk that bypass the FSOC
The Retail “Disintermediation Premium” and Systemic Risk
While the Direct Retail Clearing model eliminates broker layers, retail participants suffer a severe structural deficit in legal rights compared to traditional intermediated markets. Retail traders lose their protected status as “Public Customers” and are legally classified as institutional “Direct Clearing Members” under Part 39. They sacrifice suitability rights and access to the NFA's low-cost Arbitration Program.
If a vertically integrated platform or DCO experiences an operational failure, a smart-contract hack, or an internal bot-trading glitch, a retail user faces the liquidation estate directly without a broker cushion. Another concern is the Compression Loop. Under Part 190 bankruptcy mechanics, uninvested cash balances sitting idle on the platform are swept alongside active wagers into a single pool of “Member Property” that is subject to strict pro-rata haircuts. If a platform runs portfolio compression cycles right before insolvency, individual retail trade identities are permanently erased and consolidated into institutional blocks, effectively trapping retail funds inside prolonged forensic litigation. The maximum loss for a direct retail participant extends well beyond 100% of their active wagers, encompassing 100% of the uninvested cash sitting idle in their platform account balance.
Such platform is under no obligation to act in the best interest of the customer, given retail participants are merely treated as counterparties without fiduciary responsibility. The Commission should heed the lessons from several headline cases, where public trust is already eroding. By conflating the legal boundaries between clients and counterparties, the proposal strips away time-tested bankruptcy protections, transforms unprotected retail balances into institutional shock absorbers, and leaves systemic risk trackers blind to cross-border capital concentrations via localized data silos.
Technical & Macro-Prudential Surveillance Vulnerabilities
The proposal’s technical reporting alterations generate critical systemic blind spots across the broader financial network:
The Interoperability Illusion: The provision allowing a platform-native contract ticker symbol to serve as the UIC “where practicable” must be rejected. This approach deviates from the global UPI standard mandated by prudential regulators, creating a localized data silo that leaves macro-prudential supervisors blind to cross-border risk concentrations.
The Information Silo: Shifting data directly into the Part 16 futures framework feeds raw transaction records exclusively into the CFTC's internal databases. Prudential banking regulators in this are cut off from automated telemetry pipelines, creating an information gap that undermines the systemic safety mandates of Title VIII under the Dodd-Frank Act.
Analysis of Specific Rulemaking Provisions
- §16.03(a) Covered Event Contracts: The current draft fails to prevent unintended institutional “scope creep” because it relies on abstract contract types rather than strict venue boundaries. Furthermore, its four-prong definition discriminates against product innovation by strictly limiting the regime to binary “all-or-nothing” contracts, penalizing risk-mitigated structures like CBOE’s partial or variable “Payout Zone” frameworks.
- §17.00(j) and §17.01(f) Large Trader Tracking: Bifurcating the reporting duties between DCMs (for direct members) and FCMs (for intermediated clients) creates a blind spot that obscures a large participant's true consolidated positions. By basing the reporting burden on platform access methodology rather than entity classification, the rule grants a compliance subsidy to sophisticated hedge funds and high-frequency market makers operating as direct clearing members.
- §16.03(e) Volume-Based Reporting: Deploying a flat volume threshold of 125,000 contracts is appropriate given the ultra-short-term, rapid-turnover nature of retail binary options. Yet, we do have concerns with direct-clearing platforms frequent use of portfolio compression cycles to tear up and delete offsetting, redundant trades to shrink their reported risk. Also, there are concerns are about Form 40 Special Call burden on retail traders.
- §16.03(g) Trader-Identifying Information: Requiring execution venues to collect and continuously audit non-anonymous participant data — including names, physical addresses, occupations, and employers — is out of proportion and highly duplicative. This mandate creates a massive data privacy honeypot for cybercriminals, while simultaneously deterring institutional professionals from participating, ultimately starving the prediction market of fundamental liquidity.
Regulators must beware of the disintermediation trap and the hidden systemic risks that bypass the FSOC. Given the clear merits of the statutory separation mandated by the CEA, the U.S. cannot and should not adopt the EU/UK MTF model; consequently, a formal update to Part 39 remains inevitable. Our key recommendations are as follows:
- Mandatory Retail Spin-Off: Force vertically integrated platforms to completely spin off their retail business units into separate corporate entities to preserve arm's-length execution standards.
- “Opt-In Risk” Clearing Safe Harbor: Exempt 100% pre-funded, non-intermediated tech-clearing utilities from mutualized banking default insurance funds, operating instead under a strict "opt-in risk" regime where users are explicitly not covered by the collective safety net.
- Establish an Interagency Framework: Abandon isolated staff no-action letters and work directly through the Financial Stability Oversight Council (FSOC) and the Interagency Risk Committee to reconcile platform efficiency with global systemic safety standards.
 Data Boiler is a Pioneer in FinTech with patented inventions (US, Canada, Singapore, Japan, Australia, and 20 European countries) in signal processing, trade analytics, machine learning, time-lock cryptography, etc. We frequently comment on regulatory policy both domestically and abroad with over 12 years in business. A type C Member of the European Commission’s Data Expert Group + former committee of BITS (Bank Policy Institute). |
