The controversy surrounding prediction markets like Polymarket isn’t whether insider trading is illegal—it is. The central problem is a profound legal contradiction: existing statutes explicitly prohibit insider manipulation, yet the absence of active surveillance and enforcement in DeFi makes the practice feel permissible to participants.
This disconnect creates a dangerous enforcement vacuum, exposed by the sentiment that “unregulated betting markets… are the perfect place to do insider trading,” even though the legal framework to prosecute that exact behavior has existed for decades.
The Dual Legal Perimeter
Regulators do not need to invent new laws to deal with insider trading in prediction markets. They need only to clarify the classification of the underlying instrument and apply existing statutes. In the U.S., the legal perimeter is managed by two agencies:
The Securities Hook: SEC Rule 10b-5
The Securities Exchange Act of 1934 and its implementing SEC Rule 10b-5 are the foundational statutes used to prosecute insider trading and market manipulation in securities.
- Core Statute: Section 10(b) prohibits any manipulative or deceptive device in connection with the purchase or sale of a security.
- Implementing Rule: Rule 10b-5 criminalizes employing any scheme to defraud, making any untrue statement of a material fact, or engaging in any act that operates as a fraud or deceit.
- Applicability: If a prediction token or event contract is deemed a security (an investment contract), the SEC can apply these rules directly.
The Commodities Hook: CFTC Section 6(c)(1)
The Commodity Exchange Act (CEA) and CFTC Section 6(c)(1) provide the parallel authority for non-security markets.
- Core Statute: Section 6(c)(1) prohibits any manipulative or deceptive device in connection with any contract of sale of any commodity in interstate commerce.
- Applicability: The Commodity Futures Trading Commission (CFTC) classifies crypto assets like Bitcoin and Ether as commodities. Since prediction markets are often framed as “event contracts,” CFTC has asserted jurisdiction over them, including fining Polymarket in 2022.
The Contradiction: Law on the Books vs. Law in Action
Commentators often cite the lack of regulation as the reason insiders exploit these markets. This reflects the practical reality, which fundamentally contradicts the legal theory.
Why They Seem Contradictory
- Legal Theory (Statutes): Insider trading is explicitly illegal under SEC Rule 10b-5 and CFTC Section 6(c)(1). The laws are designed to ensure fair and transparent markets.
- Practical Reality (Unregulated DeFi Markets): Due to the lack of active surveillance, mandatory disclosures, and anonymous participants, no enforcement presence is felt. This creates an environment where insiders can exploit information asymmetry (e.g., trading on unreleased Google Trends data) without immediate consequence.
The Enforcement Gap
This gap between law and practice is the source of the market’s fragility:
- Unclear Jurisdiction: The uncertainty over whether a prediction token is a security, commodity, or wager creates a jurisdictional gray zone, slowing down enforcement actions.
- Absence of Surveillance: Unlike traditional markets that have mandatory real-time market surveillance, DeFi markets rely on passive, on-chain data that can be complex to trace, leading to enforcement lag.
- Minimal Deterrence: Without active prosecution, insiders are emboldened to manipulate outcomes until regulators finally step in.
Dual Enforcement Ledger and Classification Risk
The dual enforcement structure requires participants to monitor the signals that determine which regulator—and thus, which set of rules—applies.
Jurisdictional Split: SEC vs. CFTC
- SEC Focus (Securities): Enforcement focuses on tokens or contracts classified as securities (ICOs, investment contracts), emphasizing disclosure and registration.
- CFTC Focus (Commodities): Enforcement focuses on tokens classified as commodities (Bitcoin, Ether) and derivatives, emphasizing market integrity and anti-fraud provisions (Section 6(c)(1)).
- Prediction Market Status: The CFTC’s prior action against Polymarket signals that prediction markets are primarily treated as commodities/event contracts, making the CFTC the likely primary enforcer in the U.S..
Classification and Immunity
Polymarket’s controversy isn’t about whether insider trading laws exist—they do. It’s about which regulator claims jurisdiction. The SEC and CFTC both have statutory hooks, but the CFTC has already acted once, signaling that prediction markets are treated as commodities/event contracts. Insider trading and manipulation are prosecutable under all relevant legal frameworks—the uncertainty lies in who enforces it, not whether the conduct is illegal.
Conclusion
Insider trading is illegal in theory, but tolerated in practice within unregulated DeFi prediction markets. The statutes exist; enforcement is the missing link. Being “unregulated in practice” means lack of active oversight, not legal immunity. Traders should assume that insider manipulation is prosecutable, even if regulators haven’t yet built the infrastructure to monitor every market in real time.