“People will endeavor to forecast the future and to make agreements according to their prophecy.” — Justice Oliver Wendell Holmes Jr. (1905)

For more than a century, Chicago has been a premier global hub for derivatives trading. Its exchanges originated as places for local farmers to sell crops at set prices in between harvests and for consumers to purchase grains at transparent prices throughout the year. The introduction of standardized futures contracts made the process more efficient and, over time, exchanges added other products. Today, CME Group – operator of the Chicago Mercantile Exchange and the Chicago Board of Trade – facilitates more than 25 million trades per day across commodities, interest rates, foreign exchange and equities.

Initially, trading took place principally between merchants and consumers – parties who were committed to the physical delivery of goods. Eventually, speculators entered the fray, prefering to close out positions for cash rather than deal with delivery. Although they contributed to volume and added market liquidity, their presence was not universally celebrated.

“This horrible curse of wheat gambling has been one of the chief causes of our misfortunes,” a Minnesota wheat farmer complained to the chairman of the House Committee on Agriculture in January 1892. “What business has a man (or a devil) selling or pretending to sell, a food product which he does not possess? … These men who ‘operate’ on the boards of trade (more appropriately called gambling hells) have no right to the consideration of honest men than the devil has to a seat in heaven.”

William Hatch, chairman of the House Committee on Agriculture, proposed a bill to curb speculative activity – what he dubbed “fictitious dealings in agricultural products”. Although it passed, it floundered on its way to the statute book, and it would take a Supreme Court ruling in 1905 to resolve the issue. By then, at least three-quarters of all futures transactions involved no physical handling of any grain. A case, Board of Trade v. Christie Grain & Stock Co., considered the legality of futures where delivery was not anticipated. By a majority, the court gave the market the green light. “Speculation of this kind by competent men is the self-adjustment of society to the probable,” wrote Justice Oliver Wendell Holmes. 

Yet even with the approval of the Supreme Court, futures trading frequently rubbed up against state anti-gambling laws and it took federal intervention – the Futures Trading Act of 1921 – to give the market its footing. The legislation recognised the benefits that commodity futures can bring to commerce by facilitating hedging and improving price discovery. Not everyone was happy. “The grain gamblers have made the exchange building in Chicago the world’s greatest gambling house,” said one senator. “Monte Carlo or the Casino at Habana are not to be compared with it.”

In the years since, the characterization of financial futures as a form of gambling has persisted. When the chief executive officer of the Chicago Mercantile Exchange traveled to Geneva in 1984 to market his “exciting new futures instrument” (stock index futures), he railed against the stereotype of a futures exchange as “a marketplace where only speculation occurs and ‘wild-eyed gamblers’ drive prices up and down.”

By then, the exchanges were already under the purview of the US Commodity Futures Trading Commission (CFTC), established in 1974 to regulate derivatives markets. The CFTC was granted exclusive federal jurisdiction over futures trading including the authority to approve new contracts. Most of the time, it didn’t stand in the way. As we discussed in Smashing the Monopoly, interest rate futures grew to become a huge market following their introduction in 1975; stock index futures followed.

But in 2008, the CFTC started looking at “event contracts”. Such contracts allow participants to take a view on a future event – the result of a political election, say, or the outcome of an entertainment event. Like financial futures, event contracts are perceived to have a speculative edge to them. For the CFTC, though, they are a bridge too far. This May, the regulator proposed a rule that would ban a class of event contracts including those linked to the outcome of elections, awards ceremonies and sports games, deeming them “contrary to the public interest”. 

The proposal comes as event contracts grow in popularity. In 2021, more event contracts were listed for trading than in the prior 15 years combined. This month, brokerage firm Interactive Brokers added event contracts to its platform, allowing customers to trade on the outcome of key economic and climate events. If you think US GDP will exceed 2.4% in the latest quarter, you can pay $0.70 to win a dollar (caution: the market is not very liquid). 

Election markets prove particularly popular. On Polymarket, an event contract marketplace founded in 2020 (ostensibly not available to American users), over $765 million has already been staked on the outcome of this year’s presidential election. The CFTC’s proposal to ban such activity attracted 822 public comments before the comment period closed earlier this month, up from 31 when the regulator first sought comment in 2008. 

But is there a fundamental difference between futures markets and event contracts? Don’t all markets contain an element of gambling? To find out how prediction markets are shaping up to the challenges of regulation, read on...