Kalshi and Polymarket under investigation for “sports betting,” risking trade cancellations and market closures

On January 9, Tennessee’s sports betting authority dispatched a series of letters that, at first glance, resembled the kind of documentation most crypto enthusiasts tend to overlook.

The communication was straightforward: cease providing sports-related event contracts to Tennessee residents, cancel any unsettled positions, and issue refunds to customers by January 31.

The recipients, Kalshi, Polymarket, and Crypto.com, operate at the intersection of finance and gambling.

A “yes/no” trade based on the outcome of a game can be interpreted either as a federally regulated derivative or as an unlicensed sportsbook.

Within a few days, the dispute escalated to federal court.

A U.S. district judge in Nashville, Aleta Trauger, granted a temporary restraining order preventing Tennessee from enforcing its cease-and-desist order against Kalshi as the case unfolds. She also scheduled a hearing for January 26 regarding a longer-term injunction.

Tennessee asserts that the company is conducting an illegal gambling operation without a state license and facilitating underage betting.

Kalshi contends that Tennessee is attempting to regulate products that fall under the exclusive jurisdiction of the Commodity Futures Trading Commission (CFTC).

The immediate narrative involves a state crackdown and a compliance deadline.

The broader narrative is a jurisdictional stress test: Can a state sports wagering council isolate contracts that a federally designated exchange claims the authority to list nationwide?

If states continue to exert pressure, what will happen to the most promising new retail channel crypto has discovered since memecoins: an interface that transforms current events into tradable contracts?

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The jurisdiction fight: who gets to decide what this is?

We must start with the uncomfortable reality that both parties present a credible-sounding legal theory.

From Kalshi’s viewpoint, it’s not a sportsbook. It’s a designated contract market, the CFTC’s term for an exchange regulated under the Commodity Exchange Act, similar to a traditional futures venue that can accommodate retail participants.

The CFTC has publicly characterized designated contract markets as exchanges operating under its supervision.

In 2020, the agency announced it had granted KalshiEX an order of designation as a contract market.

Kalshi’s legal stance relies on a strong clause in federal commodities law: the CFTC “shall have exclusive jurisdiction” over specific derivatives transactions, including those traded on a designated contract market.

This language exists because Congress intended to establish one national referee for derivatives, rather than 50 state rulebooks.

From Tennessee’s perspective, none of that is relevant if the product, in essence, is sports wagering.

The Tennessee Sports Wagering Council (SWC) manages sports betting under state law, encompassing who is eligible to bet (the letters and associated reporting mention over 21 requirements), what consumer protections are in place, and what taxes licensed operators must remit.

The SWC accused the platforms of offering sports contracts without a license, breaching state eligibility rules, and lacking necessary protections.

All of this language positions event contracts as a consumer and public-interest issue rather than a financial innovation.

This is where prediction markets intersect with America’s unique regulatory landscape: derivatives are primarily federal, while gambling is predominantly state-regulated.

Sports betting, in particular, is intensely localized.

If a product can feasibly be categorized as either a derivative or a wager, the issue becomes which system is permitted to define it first.

Tennessee’s case arises after a notable loss for Kalshi in Nevada, where a federal judge determined that the platform was subject to state gaming regulations, a ruling that Kalshi has appealed.

This Nevada judgment undermines the clear “federal preemption” narrative and empowers states that view sports contracts as a loophole around licensing systems they have worked hard to establish.

Simultaneously, the CFTC itself has sent mixed signals, partly intentionally.

On its website, the agency describes event contracts as derivatives whose payouts are linked to specified events (economic indicators, weather, damages from a hurricane).

It also highlights that CFTC Regulation 40.11 prohibits event contracts that reference terrorism, war, gaming, or actions unlawful under state or federal law, among other categories.

Gaming is the pivot point. If sports outcome contracts are perceived as “gaming,” they fall into the prohibited zone.

If they are framed as “information contracts” with economic utility, they reside in the tradable realm that the CFTC oversees.

In 2025, the CFTC issued an advisory indicating that sports-related event contracts listed on designated contract markets had been listed through self-certification.

The advisory stated that the Commission had not yet taken official approval action on listing sports-related event contracts under certain CEA provisions.

While the advisory had minimal practical impact on the market, its wording suggests a regulator leaving itself the option to intervene later.

Thus, when Tennessee asserts its position, it isn’t merely challenging Kalshi, Polymarket, or Crypto.com.

It’s testing whether the federal system will uphold the principle that a nationally regulated derivatives exchange can list sports-related contracts, and whether the CFTC will accept the category evolving into a parallel sportsbook industry.

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Compliance theater: what platforms do when the law is both everywhere and nowhere

The common perception of compliance is a checklist: adhere to the regulations, submit the forms, and move forward.

This approach is effective when the rules are straightforward and the regulator is singular.

However, prediction markets do not enjoy that advantage.

They function within a jurisdictional overlap, and this overlap generates a distinctive type of compliance behavior.

You might refer to it as compliance theater, not because it’s insincere, but because it’s performative.

Every action you take, and every statement you make in the compliance theater, conveys a message about who you believe possesses authority.

If a platform receives a cease-and-desist letter and promptly geofences the state, refunds users, and voids contracts, it mitigates legal risk and avoids penalties.

Yet, it also implicitly acknowledges that the state regulator’s theory is enforceable.

If it opts to resist, it may maintain its legal position but risks escalating enforcement actions, including civil fines and possible criminal referrals.

It may also face months of litigation to remain operational.

Reports on the Tennessee letters noted potential civil penalties of up to $25,000 per violation for noncompliance.

Kalshi decided to pursue litigation.

Reuters reports that the company contended Tennessee was unconstitutionally attempting to prohibit contract trading on its platform.

The judge’s temporary restraining order implies that the court believes Kalshi may have a legitimate case, at least at this preliminary stage.

However, even a victory comes with costs. Legal proceedings are slow, while markets move quickly.

If an exchange is embroiled in litigation across eight states simultaneously, as Reuters reported Kalshi has been, operational certainty becomes a rare commodity.

Compliance teams, product strategies, and partnerships are all influenced by what the next state might do.

The performative aspect also manifests in product design.

Platforms can raise minimum age limits, implement “responsible gambling” tools, enhance AML processes, and tighten geo-controls as much as they wish.

However, each modification can be interpreted in two ways.

A state regulator may interpret it as: You’re acknowledging this is gambling.

A federal derivatives advocate may interpret it as: You’re behaving like a mature market operator, similar to brokerages that restrict certain high-risk products.

This is why the Tennessee letters hold significance beyond Tennessee.

A state-by-state enforcement strategy leads to market fragmentation.

Liquidity gets divided into permitted jurisdictions, user experience suffers, affiliate distribution becomes more challenging, and the product category ceases to resemble a nationwide market.

Instead, it begins to resemble an app with 50 different iterations.

This fragmentation is precisely what crypto-native distribution was meant to circumvent.

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Information market or sports betting: the category identity crisis

In financial regulation, products are frequently assessed based on their economic purpose and market structure.

Futures and options exist not merely for speculation but also to hedge, discover prices, and transfer risk.

Gambling laws, in contrast, are constructed around consumer harm, addiction risk, and the integrity of games.

Event contracts can credibly assert the first angle when the event is economic.

A contract that settles based on a CPI print, for instance, can serve to hedge inflation exposure or express a viewpoint on macro risk.

This framing aligns with how the CFTC depicts event contracts on its website, as macroeconomic indicators are one of the examples it highlights.

Sports are more challenging.

What economic risk is mitigated by a binary contract on the outcome of a football match?

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Some proponents argue that sports markets aggregate dispersed information (injuries, weather, strategy) and can function as high-signal prediction tools.

Critics counter that the simplest explanation is the most accurate: it’s a bet on a game, presented in a format that conveniently circumvents sportsbook licensing.

The law anticipates this contention.

The CFTC’s 40.11 rule explicitly restricts event contracts associated with “gaming,” and it also links prohibition to actions that are unlawful under state or federal law.

This is precisely the lever Tennessee is engaging.

Herein lies the challenge for platforms: even if they believe sports contracts are permissible derivatives, the public-policy argument for them is weaker than that for election odds or inflation markets.

This is significant because the CFTC’s authority in this domain is more than just technical; it carries a public-interest dimension.

Reuters reported in 2024 that the CFTC proposed revisions to its event contract rule, reflecting legal pressures and the need to better justify why certain categories should be regarded as contrary to the public interest.

The underlying theme is that “Can we list it?” is not merely a statutory question; it also carries reputational implications.

Now, introduce crypto into the equation.

The retail market seeks a product that appears intuitive, social, and immediate: a trade you can grasp without needing to learn AMMs or analyze a whitepaper.

Sports event contracts represent that product.

They exist at the crossroads of fandom, real-time information, and the dopamine loop of a straightforward yes/no outcome.

That’s why the Tennessee letters specifically target the format that could restore crypto’s mainstream appeal without requiring users to engage with blockspace.

This is also why states are responding.

Sports betting constitutes a tightly regulated and highly profitable ecosystem.

If a federally regulated exchange can provide an adjacent product nationwide without state licensing, it jeopardizes the gatekeeping framework that states depend on: taxes, consumer protections, and a controlled operator list.

Even if the “event contracts” on these platforms are smaller in scale today, the precedent they set is significant.

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What happens next

If Kalshi prevails in Tennessee and similar states, the category will have a chance at legitimacy.

Then the pressure will shift to the CFTC to clarify whether sports contracts align with its public-interest mandate.

If states continue to triumph, platforms will either retreat into geofenced compliance, turning national liquidity into localized pools, or steer users toward alternatives that regulators can’t easily oversee.

The most likely near-term outcome is neither a clear federal win nor a complete state shutdown, but a convoluted middle ground.

Anticipate fragmented availability, intermittent enforcement actions, and an ongoing identity debate in which “information markets” and “sports betting” continuously exchange roles depending on the courtroom.

And that, more than the January 31 refund deadline, is what renders Tennessee’s letters a genuine market-structure issue.

They compel the industry to confront a question it has sought to defer: In America, is a tradable yes/no contract on a game a financial instrument, or merely gambling with enhanced user experience?

The post Kalshi and Polymarket face a “sports gambling” probe that could void your trades and shut down the market appeared first on CryptoSlate.