What Is a Prediction Market: Uses and Examples for Investors

A prediction market is a platform where participants buy and sell contracts tied to the outcome of future events. Prices on these contracts reflect the market’s collective estimate of how likely an event is to occur. In a winner-take-all contract, a share pays out $1 if the event happens and $0 if it does not. Therefore, a contract trading at $0.65 implies a 65% probability of that outcome. Prediction markets have been used to forecast election results, Federal Reserve rate decisions, regulatory rulings and geopolitical events. For investors, they serve two distinct purposes. They act as a source of real-time probability signals and, on regulated platforms, as a hedging tool for event-driven risk.

A financial advisor with experience in alternative instruments can help you determine whether prediction markets belong in your strategy and how to account for their tax treatment.

What Is a Prediction Market?

A prediction market is a marketplace where participants trade contracts whose value is determined by the outcome of a specific future event. Rather than buying shares in a company or a commodity, traders in a prediction market are taking positions on whether something will happen – such as an election result, a central bank decision, a corporate earnings outcome, a geopolitical event – and at what probability.

The core pricing mechanism is straightforward:

• Contract price = implied probability: In a winner-take-all binary contract, a share trading at $0.72 means the market collectively assigns a 72% probability to that outcome. A share trading at $0.28 implies 28% probability.
• Payoff structure: A share pays $1 if the event occurs and $0 if it does not. The profit or loss depends on the entry price relative to this fixed payout.
• Prices sum to $1 across outcomes: In a market with two mutually exclusive outcomes, the prices of the two contracts should add up to approximately $1 (with any remainder representing platform fees). If “yes” trades at $0.65, “no” trades at approximately $0.35.

Prediction Markets vs. Traditional Financial Markets 

In stock or commodity markets, prices reflect the expected future value of an underlying asset, such as a company’s earnings, supply and demand for oil, or interest rate expectations. 

In a prediction market, there is no underlying asset. The contract itself is the instrument, and its value terminates when the event resolves. This event-based structure means prediction markets are more like insurance contracts, or a specific type of derivative, than equity investments.

Prediction Markets vs. Gambling 

In traditional gambling, participants bet against a house that sets fixed odds and takes a margin on every transaction. But in a prediction market, participants trade against each other. Supply and demand among traders determines the price, not an operator. 

This peer-to-peer structure means prices can incorporate new information continuously, and the market can correct quickly when expectations shift. U.S. law treats event contracts differently than gambling, an important distinction when it comes to regulatory purposes.

Prediction Markets vs. Options

For investors already familiar with options, prediction market contracts occupy similar territory but with important differences. Both instruments let you take a position on a future outcome with defined risk limited to your entry price. However, options derive their value from an underlying asset like a stock or index, while prediction market contracts have no underlying asset. The value depends entirely on whether the event resolves as specified.

Options also offer variable payoffs based on how far the underlying moves, while prediction market contracts pay a fixed amount of $1 or nothing at all. This binary structure makes prediction markets simpler to evaluate for a specific event but less flexible for expressing nuanced views on magnitude. For hedging a binary event risk, such as a Fed decision or a regulatory ruling, a prediction market contract can be more precise and less capital-intensive than an equivalent options strategy.

How Prediction Markets Work

Prediction markets structure themselves differently depending on the platform, the type of event being traded, and the mechanism used to maintain liquidity.

Contract Types 

• Winner-take-all binary contracts: The most common type. One contract for each possible binary outcome (yes or no). Each share is worth $1 if the outcome occurs and $0 if it does not. The contract resolves at $1 or $0 when the event is settled.
• Multiple-outcome categorical markets: Used for events with more than two possible outcomes; for example, which party will control the Senate, which candidate will win a primary among five contestants. Shares across all outcomes should sum to approximately $1.
• Scalar or index contracts: Used for numerical outcomes, such as what will the Fed Funds rate be at year-end, or what will the unemployment rate be in Q3. These contracts pay out along a continuous range rather than as a binary.

Market Mechanisms

• Continuous double auction: Buyers and sellers post bids and asks at specific prices, and trades execute when a buyer’s bid matches a seller’s ask. This is the same mechanism used on stock exchanges and is the most common structure for larger prediction markets.
• Automated market maker (AMM): An algorithm sets prices based on a mathematical formula rather than waiting for a matching counterparty. AMMs ensure that trades can always be executed, which improves liquidity in markets where finding a willing counterparty might otherwise be difficult. Decentralized platforms like Polymarket use AMM-based liquidity providers alongside direct trading.

Capital and Currency

• Real-money markets: Kalshi, regulated by the CFTC, allows participants to trade with real U.S. dollars. Polymarket uses USDC, a dollar-pegged stablecoin on the Polygon blockchain. Real-money markets create genuine financial incentives that improve forecast accuracy.
• Play-money markets: Platforms like Metaculus and Manifold Markets use platform-specific currency with no real monetary value. These are lower-stakes environments useful for practice and for events where real-money platforms do not list markets, but they generally produce less accurate forecasts because the incentive to be correct is weaker.

How to Place Your First Prediction Market Trade

Getting started on a regulated prediction market like Kalshi requires a few straightforward steps, but understanding what you are doing before you fund an account will save you from costly mistakes. Here are five general steps to consider:

• Create and verify your account: Kalshi requires identity verification consistent with federal Know Your Customer requirements. You will need a government-issued ID and a Social Security number. The process typically takes a few minutes online.
• Fund your account: Kalshi accepts bank transfers in U.S. dollars. There is no minimum deposit, but very small accounts limit how many contracts you can buy in any given market. Keep in mind that deposited funds are used to purchase contracts, and each contract costs between $0.01 and $0.99 depending on the implied probability.
• Find a market and read the resolution criteria: Kalshi lists markets across categories including economics, politics, weather and finance. Before placing a trade, read the resolution criteria carefully. For example, a market asking “Will the Fed cut rates at the July 2026 meeting?” will specify exactly which announcement counts, what source resolves it and what happens if the meeting is postponed. Ambiguous resolution language is a reason to avoid a market entirely.
• Understand the profit and loss math before you trade: If you buy a “yes” contract at $0.35 and the event resolves as yes, you receive $1.00 per contract, a gain of $0.65. If the event resolves as no, you lose your $0.35 entry price. If you buy 100 contracts at $0.35, your maximum gain is $65 and your maximum loss is $35, before platform fees. Kalshi charges a fee on winning trades, so factor that into your expected return before entering.
• Know the position limits: Kalshi caps the maximum position size on individual markets, particularly on political event contracts. Check the position limit before sizing a trade, especially if you intend to use prediction markets for meaningful portfolio hedging rather than speculative positions.

Prediction Markets vs. Polls and Expert Forecasts

A substantial body of academic research has examined whether prediction markets produce more accurate forecasts than polls, expert panels, or statistical models. The evidence generally favors prediction markets, particularly for political and policy outcomes, though with important caveats.

The Iowa Electronic Markets

The earliest and most studied academic prediction market is the Iowa Electronic Markets (IEM), launched in 1988 by researchers at the University of Iowa. ¹ The IEM allowed participants to trade small-dollar contracts (between $5 and $500) on presidential election vote shares. 

A landmark 2008 study by Berg, Nelson, and Rietz compared IEM vote-share prices against 964 national polls across the five presidential elections from 1988 to 2004, and found that the market’s forecasts were closer to the actual outcome than the polls 74% of the time. ²  The IEM demonstrated that even a small real-money market with engaged participants could aggregate information more accurately than survey-based methods. 

The 2024 U.S. Presidential Election

The 2024 election was the highest-profile real-world test of modern prediction markets. Polymarket’s “Presidential Election Winner 2024” market processed more than $3.6 billion in total trading volume, making it the largest prediction market event in history. ³

Throughout October and the weeks before Election Day, prediction markets including Polymarket assigned Donald Trump a substantially higher probability of victory than national polling averages implied, even as those averages showed the race as essentially tied. Prediction markets proved more accurate than the oft-cited polling averages, and the contrast renewed academic and journalistic interest in their potential as a forecasting tool.

How Investors Use Prediction Markets

For investors, prediction markets serve two distinct roles:

1. As an information source for real-time probability estimates. and
2. On regulated platforms, as an instrument for hedging event-driven financial risk.

The following chart sums up some of the common uses for prediction markets: 

Legal Status, Risks and What Investors Should Know

The regulatory and risk landscape for prediction markets varies significantly depending on the platform, the type of contract and where the investor is located.

Regulatory Status in the United States

• Kalshi (CFTC-regulated): Kalshi operates as a designated contract market (DCM) regulated by the Commodity Futures Trading Commission, a status it has held since 2020. Its event contracts are legally recognized as financial instruments rather than gambling products, and U.S. residents can trade them in real dollars. When the CFTC sought to block Kalshi’s political event contracts as prohibited “gaming,” Kalshi challenged the agency in court. A federal district court ruled in Kalshi’s favor in September 2024, finding that the CFTC had erred in treating the election contracts as gaming, and the CFTC subsequently dropped its appeal in 2025. ⁴
• Polymarket (blockchain-based): Polymarket is a blockchain-based prediction market that uses the USDC stablecoin rather than dollars directly. In 2022, it settled a CFTC enforcement action by paying a $1.4 million civil penalty over charges that it operated an unregistered facility for event-based binary options, and it subsequently barred U.S. users and moved offshore. ⁵ Its price data remained publicly accessible and widely cited throughout this period. In late 2025, Polymarket acquired a CFTC-licensed exchange and received regulatory approval to return to the U.S. as a federally regulated, intermediated platform, ending the period in which U.S. residents could not legally trade on it. Investors should verify Polymarket’s current regulatory status before trading, as this situation was still evolving at the time of publication.

Key Risks

• Liquidity risk: Markets with low trading volume produce wider bid-ask spreads and are more susceptible to price manipulation. Before entering a market, check the outstanding contract volume and recent trading activity. A market with less than $50,000 in outstanding contracts is generally considered thin.
• Manipulation risk: Bad actors can attempt to move prices in low-volume markets to create false signals, or to profit on a contract by influencing the underlying event. Regulated platforms have rules and monitoring to address this, but it remains a concern particularly on unregulated venues.
• Counterparty and platform risk: On unregulated platforms, there is no guarantee that the platform will honor winning contracts, will remain solvent, or will resolve outcomes fairly. Regulated platforms like Kalshi are subject to CFTC oversight, capital requirements and dispute resolution processes that provide structural protections.
• Outcome resolution risk: Every prediction market contract requires someone to determine when and how the event has resolved. Disputes about outcome definitions, what exactly counts as a “yes,” can affect payouts. Well-run platforms publish clear resolution criteria before markets open; investors should read these before placing a trade.

Tax Treatment

Prediction market winnings are generally treated as ordinary income for U.S. tax purposes, similar to other short-term trading gains. On CFTC-regulated platforms like Kalshi, event contract gains and losses may qualify for treatment under IRC Section 1256, which allows 60% of gains to be taxed at long-term capital gains rates and 40% at ordinary income rates, a meaningful advantage for active traders. ⁶ Tax treatment can vary by platform structure and individual circumstances, and investors should consult a tax professional.

Frequently Asked Questions About Prediction Markets 

What is the counterparty structure?

Bottom Line

A prediction market is a platform where participants buy and sell contracts tied to future events, with prices reflecting collective probability estimates, a contract trading at $0.65 implies a 65% likelihood of that outcome. Unlike polls, prediction markets create financial incentives for accurate forecasting, which is why they have historically outperformed surveys on major events including the 2024 presidential election, where Polymarket handled more than $3 billion in trading volume, where Polymarket handled more than $3.6 billion in trading volume. For investors, prediction markets serve as both a real-time information source, tracking probabilities for Fed decisions, elections, and regulatory outcomes and, on regulated platforms, a hedging strategy for event-driven risk. Before participating, investors should verify platform regulation, read outcome resolution criteria carefully, assess market liquidity and understand the tax treatment of any winnings.

Investment Planning Tips

• Before using prediction markets to hedge portfolio risk, it may be worth speaking with a financial advisor who understands event-driven instruments and how they interact with your existing positions. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
• If prediction markets have you thinking about new ways to manage portfolio risk, here’s a roundup of 13 investments to consider.

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