Prediction markets have an inescapable insider trading problem

As I wrote in February, prediction markets have a big problem with insider trading, and this isn’t an accident. This leads to a major failure mode:

The social value of prediction markets derives from financially incentivizing insiders to divulge confidential information, but this collapses noise trader confidence in the market over time.

News of the biggest scandal yet broke two days ago, with the DOJ charging Master Sergeant soldier Gannon Ken Van Dyke for improperly trading on classified information regarding the Maduro raid. He made $400k trading on Polymarket prior to the mission. He is no junior soldier. He was a senior Green Beret with meaningful planning and operational responsibilities regarding special forces operations.

As a brief aside, though many people are calling for him to get a light slap on the wrist due to rampant (legal) insider trading activity in Congress, he still deserves a prison sentence. What he did was risk tipping off the Venezuelans that a raid was coming via his trading activity, which is morally as well as legally problematic. It seems the Venezuelans did not notice, but the government cannot accept a precedent where its elite operators are leaking details of forthcoming operations through market activity. I am sympathetic to Van Dyke, but he still broke the law and violated the secrecy he is sworn to for personal gain.

This is just the latest in a string of real or suspected insider trading scandals on prediction markets. Previously, Israel arrested two reservists for trading on Polymarket with classified military intelligence. Markets regarding the start of the Iran war, the ceasefire, the killing of Ayatollah Khamenei, and Biden’s pardons have also come under suspicion, though no arrests have been made. Kalshi and Polymarket have also flagged and suspended accounts trading on markets concerning themselves, like the three congressional candidates betting on their own races.

Now you might imagine that these issues will simply go away as more people come to realize that trading with confidential information is illegal not just in securities markets, but on prediction markets too, but I think the problem runs deeper than that.

The premise of prediction markets is that they are informationally efficient because they reward informed insiders.

Or, in other words, prediction markets are “good” because they bring together armies of uninformed noise traders, who create a financial reward for insiders¹ to take their private information and release it into the public domain. (This concept – noise traders creating the incentive for informed insiders to participate – is well established in the financial literature, but a recent paper further extends it to prediction markets.) The PMs can then reliably advertise themselves as socially useful, since they genuinely provide better and more up-to-date signals than other platforms (experts, polls, etc). Kalshi and Polymarket know this, but are loath to explicitly admit it. But they do hint at it in their marketing!

Kalshi’s CEO Tarek Mansour had a discussion on the Sourcery podcast and explicitly said “there is no insider trading in commodities. It’s all insider trading actually”, which is… an extremely creative interpretation of the law. He adds:

I think there is some subset of information that is nonpublic that [traders] cannot trade on, but I think we are being a bit too restrictive right now.

Kalshi has used the promotional language “trade on anything” and “everyone is an expert on something”, both of which imply that ordinary people that might happen to have some privileged information can monetize it on the platform.

Polymarket CEO Shayne Coplan had this exchange with CBS last year:

Anderson Cooper:

But predictive markets do rely on someone having some inside information.

Shayne Coplan:

Uh-huh. Yeah. I think that people going and having an edge to the market is a good thing. Obviously, you need to curate them and you need to be really clear and stringent on where the line is drawn and, like, sort of ethics and we spend a lot of time on that. But it’s sort of an inevitability that this will happen, and there’s a lot of benefits from it. And, you know, people will adapt.

Shayne has also said that prediction markets are “the most accurate thing we have as mankind right now, until someone else creates some sort of a super crystal ball”. Some of that accuracy comes from insiders.

Vlad Tenev, Robinhood CEO (partnered with Kalshi) has said:

Prediction markets actually give you that news faster, in some cases before it even happens. I think it certainly has enormous economic value.

Robin Hanson, an economist who many see as the godfather of prediction markets, has bitten this bullet directly and issued lengthy defenses of insider trading in PMs. In 2024 he said:

If the point of [prediction] markets is to get accurate information on the prices, then you definitely want to allow insiders to trade, even if that discourages other people from betting because that makes the prices more accurate. And that’s the priority.

I must note that both Kalshi and Polymarket have anti-insider trading policies. Kalshi is CFTC regulated and has always explicitly banned trading on MNPI and engages in market surveillance. When I wrote my last blog post in February, I noted that Polymarket did not explicitly sanction insider trading, but in March they updated their rulebook and added a detailed ban the following types of trading:

• Trading on stolen confidential information (if you are a soldier, battle plans do not belong to you, but to the government)

• Trading on illegal tips passed to you by an insider

• Trading on any contract where you can influence the outcome

The point of this section is not to browbeat Kalshi or Polymarket or their leadership for gesturing at traders having informational advantage. I think their policies (post the March 2026 update) are sufficiently clear. Instead, I am pointing out the fundamental tension plaguing these markets:

Prediction markets depend on informed traders to produce accurate prices, but they also depend on uninformed traders to create an economic incentive for informed flow. This creates a tension:

• If insider trading is too permissive, uninformed traders may exit due to perceived unfairness

• If insider trading is too restricted, the market may exclude its most valuable information sources

As a consequence, informational efficiency and perceived fairness trade off against each other. Here’s the same idea in visual format:

So we end up with a couple different failure modes:

1. Too many sharks eat all the fish

The insider trading standards are too loose, and the markets become quite informationally efficient, but the noise traders end up with the distinct feeling that the market is “rigged” and that they are constantly trading against insiders. As such, the noise traders leave, and the markets end up being less liquid. This is the failure mode I talked about previously. This is where we are at the moment, but I think we are going to rebound in the other direction.

2. No sharks, no edge

This is the other end of the spectrum. Insider trading end up being rigorously policed on the platforms with real time market surveillance and robust regulatory reporting, and the informed flow stays away. These markets therefore produce less socially-valuable information and become mere aggregators of sentiment, rather than producing “the news before it happens”. As such, the platforms aren’t able to market themselves as effectively.

The existential question is whether there is a happy medium where liquidity is maximized, noise traders feel like markets are “fair enough”, and informed flow can still get paid for their information collection. The chart suggests there may be, but reality is messier.

My prediction from February remains. As I said then:

Serious risk remains that insider trading scandals will give retail traders the impression that markets are rigged, causing them to desert the platforms. I predict that this year, a flurry of insider trading episodes will convince the platforms to dramatically beef up market surveillance, and cause Polymarket in particular to move away from the pseudonymous model

I expect that Polymarket will completely eliminate the ability to trade without KYC (this is the case on the non-US platform right now) and will ramp up their flagging of suspicious trades on the platform. There will be a flood of criminal cases regarding stolen insider information, but the temptation will remain. Though the platforms won’t admit it, there really is a “socially optimal” amount of insider trading. But can they calibrate optimally? And will the regulators allow them to?

1. It’s worth noting that not all informed traders are insiders. You can inform yourself by collecting public information and trading on it. But some subset of informed traders are indeed insiders misappropriating information