Why Kalshi's Rough Week Could Reach the Supreme Court: DEX in the City

Transcript

Frankly, there's so much news happening about prediction markets every second of every day that we've specifically tried to avoid talking about them every week because some of this starts to feel legally and functionally repetitive even though it's hitting the headlines. Well, we've gotten to the point now where today it is unavoidable to talk about some of the prediction markets and in particular Khi has had a rough week, you guys. Um, there's a bunch to unpack here, but I'll I'll dig in with probably the most important piece of this. So, I'll refresh everyone. Basically, prediction markets are suing states. States are suing prediction markets. The CFTC is

suing states. It's a mess. Okay. >> The love triangle. >> It is a It is a dysfunctional love triangle. uh all over a slew of nerdy legal interpretation that we'll unpack a little bit. But back in March, the state of Michigan sued Khi, saying that Koshi's sport events contracts are actually betting. So Khi needs a Michigan gaming license. And this goes back to something we've covered on the show before, but basically it's an interpretation of whether gaming and these sports event contracts in particular listed on federally CFTC registered designated contract markets which are exchanges for derivatives are actually gaming or gambling or not.

Okay, so this is the crux of the issue. Federal jurisdiction, CFDC jurisdiction versus state jurisdiction. Well, Michigan sued Khi. This litigation is proceeding. I think anyone who is a lawyer will understand that litigation takes months at a minimum, if not years. But post their actual lawsuit, they successfully sought and got something called a temporary restraining order or a TTRO. And that happens a lot in litigation where it's like the plaintiff says, "Hey, you're doing something bad.

you're doing something damaging, but while the lawsuit is proceeding to figure out if you're doing the bad thing or not, I'm asserting that you're doing this bad thing. So, I'm going to seek a TTRO to stop you from doing the alleged bad or violative conduct. >> Let me just jump in there and say it does happen sort of a lot, but it's actually a super high burden. >> Correct. >> The person who's asking for it has to show like a high likelihood. I don't want to get into the legal ease of it. a high likelihood of success. And so the judge has to think it is worth it enough to put a stop to this based on allegations alone because it seems like they're going to be successful. So it is

a high burden. >> Absolutely. Which is why you don't see it all that often. Now other states have also similarly sought TR TRRO's against prediction markets. And what has happened for the most part is these prediction markets have just moved to geobblock the state. Says, "Okay, we're no longer going to deal with Michigan people while this litigation is proceeding." But what is somewhat unusual is not only did the judge grant the TTRO sought by Michigan, but the court also ordered Cali to liquidate the Michigan pending sports event contracts.

The other orders, the other TTRO's have basically just said Kalshi poly market prediction market just stop offering these markets and then allowed people to liquidate on their own. So Cali said, "Okay, we got a state order. We have to follow the states. Uh we're going to go ahead and geoffence Michigan." And then they moved to cancel the pending sports trades in Michigan by Michigan indivi by individuals in Michigan. So they fully complied with the judge's order and it was apparently a pretty small volume of trades. So, fairly easy to do that. Here's where it gets fun. The CFTC then went to Koshi and said, "Wait, do not cancel the trades." And they actually did this by invoking emergency powers

that they have that haven't been used since 1980. I think before any of us were even born, when those emergency powers were last used in Jimmy Carter's grain embargo against the Soviet Union during the Cold War. I really needed to refresh myself on that. So, what does this mean? This is by far the most aggressive position the CFTC has taken to assert power in these markets. And it's also a really good example of the CFTC's argument for preeemption. And the CFTC all along, echoed by the other prediction markets, has said federal law needs to preempt states when regulating these exchanges and these contracts to avoid preventing to avoid placing the platforms in an

impossible situation because now Khi was faced with a situation where it's like we adhere to a judge's order and you know basically violate an order from our federal regulator or vice versa. It's they're an impossible situation. They're in between a rock and a hard place. So, it's it's very difficult. I thought that this was like super bonkers and also like because I thought it was relevant, I looked into the history of it a little bit and the fact that this like break glass emergency power has only been used about four times in the history of the CFTC and they were for when like markets were actually on fire. whether it be

like a potato contract historic default, like a coffee price spike, some like attempt to corner the silver market, and then what you were talking about the grain embargo with President Carter. So, it's worth having a conversation here about why the CFTC did this, how it relates to the prior four times it's being used, what this means for them using it in the future, and how are they choosing winners and losers about like which markets they quote unquote care about and want to focus on. Not to mention like that it did put Kelsey in a tough position as you mentioned, but I think like the historical context here cannot be ignored.

>> Absolutely. And when we talk about emergency powers, what we're talking about specifically is the Commodity Exchange Act gives the CFTC broad emergency authority. And this this authority was created after a bunch of market manipulation like bad episodes in the 70s. and it allows the CFTC when an emergency exists to take extraordinary action to protect the integrity of derivatives markets. However, historically this emergency authority had only been used to intervene against market participants, not against a state. So, this is also a pretty significant expansion of that emergency authority period. Does the law define what constitutes an emergency?

>> Like like many situations in the law, no, not exactly. [laughter] >> Um, so there's there's like I think the CFTC has the right to invoke the power. It's just unusual because historically the power was used because the markets themselves were malfunctioning. Like I believe the intention for these emergency powers were like manipulation or defaults or clearing house stress. That that was not this right. Like there was no emergency because a bunch of people in Michigan were trading sports events contracts. But I think one of the justifications for the commission's use of this power is the issue that we just talked about where Khi is in an

impossible position and we need to assert federal preeemption to prevent others from being put in this position. Um and the other really important point to note about this is Khi can keep fighting this lawsuit, right? Like just because they adhere to the TTRO, they can keep fighting it. that the case is not moot because even though they're not offering sport sports events contracts to Michigan, they are prevented from offering sport event contracts. And it's a big question mark like a procedural question is whether the CFTC's intervention actually makes the dispute stronger because it took a fight between Koshi and Michigan and turned it into basically a case over federalism, right?

the scope of of uh power under the commodity exchange act. It took a business dispute between a company and a state and turn it into a kind of a massive uh you know federalism fight and significantly raises the stakes >> makes the case a much stronger case for appellet review. So, >> yeah, I would say >> I think everyone assumes that it'll reach the Supreme Court uh eventually, but this like this really marks a major escalation >> of the CFTC's involvement in this area and I think it's just going to make the Supreme Court even more like eager to take this matter up. But I yeah, this is this is different than anything we've

seen happen. It's interesting because at the same time there's all these comments coming in to the CFTC about their potential prediction market regulatory structure which I think we've touched on before in prior but there's like an open comment period right now and I don't know if you guys saw but it was either today or yesterday former CFTC chair Tim Msad who's very respected in and out of crypto um but you know has strong opinions one way or another said something like the CFTC has lost its way or something like that when it comes to regulating prediction markets. So, this is interesting in that like people that really understand the space are pushing back as well and those that worked at

the federal agency and so understand the importance of having power at that agency are pushing back. And this is all in light of what you guys are saying with like the continued court cases. Like I'm sure you guys saw, but Khi lost their preliminary injunction bid in New York just last week, too. So, we've talked about many of the states. Obviously, New York is a big state for them. And so really trying to understand like, okay, maybe they I actually don't know how big of a market Michigan is, but maybe they can geoblock certain states, but they're not gonna want to geoblock Nevada. I'm sure they're not going to want to geoblock New York. So really focusing their attention on the

kinds of states that matter for them is also important. I also think like just, you know, like we're we're sort of handling these legal issues like state by state right now, but I think it's really important to take a step back and just realize how enormous the implications are for sports gambling if the CFTC and like Kelshi like ultimately prevail in this legal fight, right? Like if they win and you're a sports betting platform, why wouldn't you just like fit every sports bet into the legal form of an event contract so you can be federally regulated as a DCM and no longer have to worry about not just state by state like all the stuff that

you have to deal with state by state, right? Like the the gambling licenses and the taxes and the product restrictions and just like a hodgepodge of different consumer protection rules. Like why would anyone opt for that if they could just be subject to one federal regime that covers them for the whole country? I think people don't appreciate what the implications are like if the CFTC and Kelsey win it's going to completely transform sports life sports gambling >> and I think that's the whole crux of the issue from the state perspective is that that is inappropriate and the states want and need that jurisdiction from the state perspective. However, on the other side of the fence, there is the argument that this kind of activity is better on

designated contract markets because they operate as many self-regulatory organizations. You know, they police, they enforce, and they have federal jurisdictions. So, the federal argument is look like these contracts are better suited and more appropriate and more regulated than, you know, being at the in the purview of state gaming commissions. And it's super interesting you say that KK like as a reframing because remember all of this on the state level is largely about sports right and obviously sports is a huge part of Koshi and Poly Markets like networking and contracts but there's a lot more that I know we're going to talk about in a bit later. There's so many more types of contracts and like the concept of splitting your sports

betting/events contract from a different type of event contract particularly as it grows into a more of a hedging vehicle for compute etc. will I mean that could be a real problem too. So it could be an argument that is taken to the Supreme Court and that they may understand. >> This will definitely go to the Supreme Court. I mean, the Supreme Court is just getting chalk full of future CFTC fights right and left. I mean, but look, shifting gears a tiny bit, I said at the beginning, Cali's had a rough week because in addition to this, they also cancelled plans to offer contracts linked to airportwide canceled flights for what I would actually call policy oriented reasons more than anything

else. So, this is a dramatically different scenario than kind of the sports events contracts. We're not really talking about sports events contract in the context of manipulation. Now, of course, there's issues with potential manipulation with sports events contracts, but for the most part, or you know, people throwing games, etc., etc., but for the most part, it's more about the federalism issues, state versus federal. Other contracts, they're more manipulation centric or that is the concern. And that's what happened with these contracts. Effectively, Khi said, "Hey, like this makes sense." And I actually agree with them from a hedging perspective. They said these flight cancellation contracts can serve as really important hedging for hedging

instruments for conference organizers and people whose business are highly dependent and sensitive to flight cancellations. So this is an important way to hedge. I can actually see a multitude of >> Oh my god, is already so bad. I like I want to insert people potentially putting blockers on our flights in order to be able to make money to me like that moral hazard conversation is like do not make me have more delays at the airport.

>> Jesse hit you you're hitting the nail on the head. Okay. Like I promise I was going to get there but then again who hates travel insurance like me. Me it's you know rife with red tape. But it's hard. >> You have bought travel insurance before on this. >> I have literally never >> paid for that. >> Fair. >> You did not pay for that. >> I have never paid for it. And sometimes my companies have paid for it. But the reason I haven't paid for it is because if you actually take the moment to read the fine print with travel insurance, it's ridiculous. Okay. So, here's a different way for people to hedge their their travel in a way. and and I can see why flight cancellations really have material negative economic impact on a

slew of businesses. So, okay, we have the economic use case for it. But everybody came out and was basically like this is a terrible idea because these contracts are going to exist and there's going to be all these bad day bad guys that are, you know, driven economically to create a whole host of scary issues at airports to prompt cancellations. Even though Khi did have lots of rules to designed to prevent insiders from profiting, but of course that's that's not airtight. And then FlightAware also came out and said, "Kouchie, you can't use our data for these contracts," which actually doesn't even make sense to me because the information on this is all in the public domain. So no more flight contracts basically for rules about API

or scraping. I'm not sure where that would have come from, but I do think it's super interesting that the beginning of this is like Koshi's having a bad week because of the state versus federal argument. And then they're also getting sort of stopped by vendors and by data. So, it's it's really interesting to try and think of through being a lawyer there or an operator there and navigating all these different parties and access to information and like what can you actually do? >> Yep. Yep. I mean also like public backlash to some of these event contracts that pop up, right? Like they I mean you can tell that they respond to that.

>> Yeah. >> Being a GC of those prediction. It's not an easy job. Okay. We keep inviting some of those GCs on this pod because we know them and they don't have time to come on podcast. >> I just assume none of them are sleeping like they haven't seen their families because it's kind of busy these days with the litigation docket. But no, for real, the last thing I'll mention with Koshi is this is notable. It's just buried in all the other notable news is they've also been embroiled in some insider scrutiny surrounding Donald Trump's longtime teleprompter.

And you know, think about it. A teleprompter gets the text from the president's speech writing or comm's team before it's public. Okay, so the allegation is that this teleprompter was placing bets on Koshi. Palshi picked up the irregular activity fulfilling its DCM self-p policing obligation and now this individual is on leave. But it raises again kind of insider related restrictions and how do we prevent this sort of thing in a slew of different scenarios going forward on all prediction markets. I mean to be clear this is not a issue that's unique to Khi.

>> Yeah. I mean that one's like a no-brainer. I and I'm really happy that Kelshi was able to discover it and crack down. But to what V has said many times on this podcast before like for everyone caught like how many are doing this from anonymous accounts and like understanding or like different accounts or ones that aren't tied clearly to their profession like how many of these insider trades are happening that aren't being caught and what's our plan moving forward particularly as it expands um into different types of markets. The ones that super bother me obviously relate to national security. Um, which this is at least adjacent to, but who

knows what else is happening out there. So, good on Koshi for finding this and hopefully there's more and more tools to do so. That was a clip from Decks in the City where the wallets are cold and the takes are hot. And we've got a lot more in the full episode. Links in the show notes. I'm host Jesse Brooks. Subscribe and join us on the live stream every Tuesday at [music] noon Eastern. If you hold crypto on your phone, your biggest vulnerability isn't your wallet, it's your carrier. AT&T, Verizon, and T-Mobile have been breached again and again, and SIM swaps are still one of the easiest ways for attackers to drain accounts. That's where Cape comes in.

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