Prediction markets · Brief · 7 min read
Prediction markets: seven businesses inside the stack
What a startup can be in this market besides an exchange: the registration that applies to each of seven businesses, or the staff letter that removes it, and one public example of each from the filings.
A startup that wants to be part of the prediction-market business has more choices than building an exchange. This primer names seven businesses inside the stack, the registration each one needs or the staff letter that removes it, and one public example of each. The numbers behind them are in the deep dive on building a company in this market, and the choices for a front end are in the series on the Phantom letter.
The seven in one table
| Business | Registration that applies | Public example in the records read |
|---|---|---|
| 1. Exchange | Designation as a contract market (DCM) | DraftKings, Robinhood’s joint venture and Underdog each acquired one (filings and releases) |
| 2. Clearinghouse | Registration as a derivatives clearing organization (DCO) | ForecastEx, which Interactive Brokers says it established as an exchange and clearinghouse |
| 3. Futures commission merchant | FCM registration and NFA membership | Interactive Brokers, which publishes its event-contract commissions |
| 4. Introducing broker front end | IB registration and NFA membership | DraftKings, which says it acts as an introducing broker |
| 5. Passive-software front end | None, under Staff Letter 26-25 and its conditions | Staff Letter 26-09’s beneficiary is a wallet developer |
| 6. Market maker | Membership with an exchange; no separate registration in the records read | Kalshi’s liquidity incentive program names market makers and the members it excludes |
| 7. Infrastructure: data, settlement sources, surveillance and location tools | None specific in the records read | Each contract’s “Source Agency”; the surveillance duty on an exchange; a broker’s location controls |
The licensed core: exchange, clearinghouse and broker
The first three businesses are the ones that hold a licence of their own. An exchange needs a designation, and the regulation sets a 180-day review clock for a complete application:
The Commission will review the application for designation as a contract market pursuant to the 180-day timeframe and procedures specified in section 6(a) of the Act.
The 180 days start only when the application is materially complete; the Commission can notify an applicant that it is not and stay the clock (§ 38.3(c)). No elapsed time for any named exchange is stated in the records read.
A clearinghouse has a financial-resources rule of its own, which covers the default of its largest member and a year of operating costs:
At a minimum, each derivatives clearing organization shall possess financial resources that exceed the total amount that would: (1) Enable the derivatives clearing organization to meet its financial obligations to its clearing members notwithstanding a default by the clearing member creating the largest financial exposure for the derivatives clearing organization in extreme but plausible market conditions; … (2) Enable the derivatives clearing organization to cover its operating costs for a period of at least one year, calculated on a rolling basis.
Some companies hold both. Interactive Brokers says it set up an exchange and clearinghouse alongside its brokerage:
We also offer trading in prediction markets, which are event-based contracts traded on ForecastEx, a CFTC-registered exchange and clearinghouse we established, and on other platforms.
A futures commission merchant is the registered broker that carries the account and holds the customer’s money. The capital rule sets its floor:
each person registered as a futures commission merchant must maintain adjusted net capital equal to or in excess of the greatest of: (A) $1,000,000, Provided, however, that if the futures commission merchant also is a swap dealer, the minimum amount shall be $20,000,000; … each person registered as an introducing broker must maintain adjusted net capital equal to or in excess of the greatest of: (A) $45,000;
An introducing broker that operates under a guarantee agreement is not subject to the introducing-broker minimum in § 1.17(a)(1)(iii), as the companion piece quotes.
Kalshi’s public fee-schedule page: the standard fees row for most markets and the combos row, each showing a fee range per 100 contracts, then the non-standard series table with its fee multipliers and a count of total series.
The customer-facing businesses: introducing broker and passive software
An introducing broker solicits and accepts orders without holding customer funds. The statute makes registration a requirement, and DraftKings states how it recognizes revenue as one:
(g) Introducing broker registration requirements It shall be unlawful for any person to be an introducing broker unless such person shall have registered under this chapter with the Commission as an introducing broker and such registration shall not have expired nor been suspended nor revoked.
DraftKings acts as an introducing broker, and therefore revenue is generated from introducing fees, paid by futures commission merchants, and is recognized when customer trades occur.
The filings read do not state the introducing-fee rate or the prediction-markets revenue separately from sports revenue.
The staff position for passive software provides an alternative for a front end that only shows data and sends the user’s orders to a registrant. The activities it covers:
The PSP will develop and distribute front-end interface software for Users to review market data and aggregate position information, view information about product offerings, and submit orders for Commission-regulated derivative products directly to Registrants, including event contracts, perpetual contracts, and other Commission-regulated derivatives. … At no point would the PSP hold, control, or take into custody User assets, generate express “buy” or “sell” signals, or exercise discretion with respect to the routing or execution of User orders.
NFA’s public introducing-broker page: who is exempt from registering, then the steps to register as an IB and join NFA, with the $200 application fee and the dues line, then the separate steps and $85 fee for each principal and associated person.
The service businesses: liquidity, data and tooling
Liquidity is a service the exchanges pay for. Kalshi’s liquidity incentive program names market makers in its eligibility terms:
The purpose of this Program is to increase liquidity on the central limit order book and thereby enhance pricing efficiency. … “Eligible Participants” are all Kalshi members, except the following: (i) affiliates of Kalshi; (ii) members who have executed a Market Maker Agreement with Kalshi; (iii) Introducing Brokers, Futures Commission Merchants, and customers thereof when transacting via the IB or FCM.
The filing shows no payment amounts in the passage quoted. A market-maker business sits behind a member agreement with the exchange, and each exchange’s terms differ.
Each contract settles to a number a third party publishes, and the rulebook defines that publisher:
“Source Agency” means the agency that publishes the Underlying and/or Expiration Value for any Contract. … “Source Agency Prohibition” means the list of Source Agencies which may implicate trading prohibitions under Chapter 5 of these Rules such as if a Trader has access to material non-public information or is a decision maker.
A contract on a number published by a government agency or a league settles to that publisher. No fee for a data or oracle service appears in the records read.
An exchange also has to monitor its market. The regulation states what it must be able to do:
A designated contract market must: (a) Collect and evaluate data on individual traders' market activity on an ongoing basis in order to detect and prevent manipulation, price distortions and, where possible, disruptions of the physical-delivery or cash-settlement process; … (c) Demonstrate an effective program for conducting real-time monitoring of market conditions, price movements and volumes, in order to detect abnormalities and, when necessary, make a good-faith effort to resolve conditions that are, or threaten to be, disruptive to the market; and (d) Demonstrate the ability to comprehensively and accurately reconstruct daily trading activity
Robinhood’s public help page on event contract restrictions, scrolled from the state restriction naming Maryland and Nevada, through the position-closing-only rule applied when an eligibility or state change is detected, to the “stricter area” geolocation error and its causes.
The records read price none of these three services: no fee for market making, data or compliance tooling appears in them. They are listed because each one is a role the rules or the exchanges’ own terms assume someone fills.
What a builder does with this
- Pick the business by its registration first. A licensed business takes a designation or a registration and its own capital rule; a front end can take a registration or a staff position; a service business takes a contract with an exchange or broker.
- Read the capital and time figures that exist: a 180-day review for an exchange, a year of operating costs for an exchange and a clearinghouse, $1,000,000 for a futures commission merchant. The records read state no figure for the others.
- Look at the public example for each business before choosing it. The filings show who has built or bought each layer and in some cases what it was paid.
- Match the business to the exchange’s own programs. Kalshi’s liquidity program is built around who the participant is, so the choice of business is also a choice about which programs apply.
- Treat the infrastructure layers as roles, not as products with a published price. Collect quotes from the exchanges and brokers that would buy the service before building a model.