Traditional sports betting allows insiders to exploit static odds. In a liquid prediction market, a large bet based on inside information immediately moves the odds, reflecting that knowledge in the price and eliminating the arbitrage opportunity for the insider.

The case of a trader profiting from advance knowledge of an event highlights a core dilemma in prediction markets. While insider trading undermines fairness for most participants, it also improves the market's primary function—to accurately forecast the future—by pricing in privileged information.

Prediction markets like Polymarket operate in a regulatory gray area where traditional insider trading laws don't apply. This creates a loophole for employees to monetize confidential information (e.g., product release dates) through bets, effectively leaking corporate secrets and creating a new espionage risk for companies.

A more significant danger than insider trading is that individuals in power could actively manipulate real-world outcomes to ensure their bets on a prediction market pay out. This moves beyond leveraging information to actively corrupting decision-making for financial gain, akin to throwing a game in sports.

Unlike securities, there's a debate where some argue insider trading enhances prediction market accuracy, fulfilling their core purpose. This philosophical schism complicates regulation, as the "harm" is unclear, leaving platforms to self-police a practice some users actively defend as beneficial.

New legislation aims to ban government insiders from trading on prediction markets. However, the true edge isn't direct insider knowledge but "adjacent information"—piecing together public signals and cocktail party chatter. This mosaic-theory approach remains legal and is the core mechanism that makes these markets predictive.

Kalshi’s key strategic move was getting its prediction markets regulated by the federal CFTC, similar to commodities. This established federal preemption, meaning state-level laws don't apply. This allowed them to operate nationwide with a single regulator instead of seeking approval in 50 different states.

Extreme conviction in prediction markets may not be just speculation. It could signal bets being placed by insiders with proprietary knowledge, such as developers working on AI models or administrators of the leaderboards themselves. This makes these markets a potential source of leaked alpha on who is truly ahead.

While praised for aggregating the 'wisdom of crowds,' prediction markets create massive, unregulated opportunities for insider trading. Foreign entities are also using these platforms to place large bets, potentially to manipulate public perception and influence political outcomes.