Variant: Reflections on Insider Trading in Prediction Markets

Author: Daniel Barabander, General Counsel and Investment Partner at Variant; Translator: @jinsecaijingxz

Insider trading in prediction markets has recently become a hot topic.

Many founders have discovered that suspicious wallet addresses suddenly conduct transactions before major events, leading them to question: 'Is illegal activity occurring?' But to answer this question, 'we need to take a step back and understand the actual workings of insider trading'—something most people don't understand.

If you consult most lawyers about insider trading, you'll hear a lot of obscure legal jargon. They'll mention 'fiduciary duty, duty of care,' 'classical theory,' 'misappropriation theory,' 'information transmitter,' 'information receiver,' 'insider,' 'outsider,' and so on. Even they themselves might get confused when trying to apply these concepts to emerging fields like prediction markets.

(This is not legal advice; please consult a professional lawyer for specific questions.) Here, I would like to provide a simplified analytical framework to illustrate my general understanding of insider trading and how I believe it should apply to market prediction. Insider Trading = A Form of Fraud Regarding insider trading, the first thing you need to understand is that the law considers it a form of fraud. Like all fraud, insider trading involves deception carried out for personal gain. This deception typically stems from a breach of express or implied commitments regarding the "use of restricted information." There isn't actually a separate "insider trading law," only anti-fraud rules applicable to insider trading. The main difference between insider trading fraud and commonly recognized fraud is that the former's commitments are often more subtle, making them easier to violate. A typical pattern of insider trading is: an employee violates their commitment to their employer by using material non-public information about the company to trade stocks. Whether you agree or not, when you work for a company, you implicitly commit (as established by law) to act in the best interests of the company and its shareholders. This commitment is likely explicitly stated in the employee handbook you agreed to abide by when you joined. When employees use material non-public information to buy or sell company stock, the counterparty shareholders are at an informational disadvantage; exploiting this asymmetry constitutes a fraudulent breach of their commitment to shareholders. I've found that what people often overlook is that this is just one form of insider trading. **Anyone who fraudulently breaches an express or implied commitment in a transaction may be guilty of insider trading.** For example, suppose an employee learns that the company is involved in a merger or acquisition. Knowing that typical insider trading scenarios are prohibited, the employee attempts to "cleverly" use this material non-public information to buy shares of the company's biggest competitor, expecting the competitor's stock price to soar after the news is released. Although the employee has no implied duty of loyalty to the competitor's shareholders, this action may still constitute insider trading. This is because the employee has promised the company through company policy, confidentiality agreements, or implied duties of loyalty that they will only use confidential information for legitimate business purposes. Using this information to trade competitor stock for personal purposes clearly violates this commitment. Therefore, the employee can be considered to have fraudulently breached their commitment, thus engaging in insider trading. The commitment is key. The commitment is the core issue. Suppose someone overhears two investment bankers at the next table discussing a pending merger or acquisition deal during lunch. This person identified the target company and left the restaurant, then bought and sold its stock before the transaction announcement. Although this information was clearly material non-public information, this action generally does not constitute insider trading. This is because the trader did not make any express or implied confidentiality commitments to the investment banker, nor did they have any implied obligations to the company and its shareholders. Investment bankers may breach their obligations by speaking carelessly in public, but if the trader did not fraudulently breach their obligations, there is no fraud—therefore, it does not constitute insider trading. Anyone who fraudulently breaches an express or implied commitment in a transaction may be guilty of insider trading. Understanding this from the perspective of "fraudulent breach of commitment" corrects a common misconception: insider trading is not limited to the securities sector. Conversely, similar issues can arise in commodity markets (including derivatives markets). For example, a Cargill derivatives trader who learned through work that the company would be making a large purchase of wheat and subsequently traded in advance in the wheat futures market using their personal account could very likely constitute insider trading. In this case, the trader, through company policy, confidentiality agreements, or job responsibilities, had promised to use confidential information only for Cargill's business purposes, and their personal trading constituted a fraudulent breach of this promise. Conversely, if the trader's duties included trading on behalf of Cargill before executing purchases, it would not constitute insider trading—even though they acted based on material non-public information (i.e., knowledge of the company's planned market trading), it would not constitute a fraudulent breach of promise: the trader had no implied duty to other futures traders, and using that information to trade was an official act authorized by their employer. This also applies to prediction markets. So what does this mean for prediction market traders? My core point may be disappointingly mundane: the law itself hasn't changed. Fraud is fraud, and legal rules are flexible. The key question remains: did the trader fraudulently breach their promise through trading? Therefore, if a Tesla employee has access to fourth-quarter financial data and uses that information to trade in a prediction market for "Will Tesla's fourth-quarter results exceed expectations?", it is highly likely to constitute insider trading. This would constitute insider trading either because the employee violated a commitment to Tesla shareholders or a confidentiality agreement or other agreement prohibiting the use of company secrets for personal gain. However, if the same employee then trades in a prediction market for "Will the growth rate of U.S. electric vehicle charging demand exceed that of gasoline demand in the next two years?"—as long as they use publicly available data on electric vehicle adoption and industry expertise accumulated over years at Tesla (rather than internal Tesla plans)—it is highly unlikely to constitute insider trading because there has been no misuse of confidential information or breach of commitment. However, prediction markets will push the law to its limits and test its adaptability and potential for breaches. Traditional markets are typically linked to specific companies: securities markets are directly linked to companies (such as Tesla's fourth-quarter results), while commodity markets are indirectly linked (such as Cargill's wheat purchases). This is crucial because companies are often the source of confidentiality and business-only commitments—commitments that (whether implied by law or explicitly stated through confidentiality agreements, policies, etc.) form the basis of insider trading liability. Prediction markets expand the sources of valuable insider information by broadening the scope of tradable assets (making almost anything tradable), often involving scenarios where the existence of the relevant commitment is highly ambiguous. This is particularly pronounced in permissionless or opinion-based markets, where the relevant company often doesn't even exist. For example, suppose a high school has a prediction market for "Who will be the prom king?" Your friend, the most popular person in class, privately tells you he can't attend the prom. If you trade using this information, does it constitute insider trading? The legal question remains whether you fraudulently breached the commitment, but in this context, any such commitment must be implied from your relationship or the circumstances of the disclosure, not from an explicit obligation or formal agreement to the company. This makes insider trading prosecution extremely difficult. The boundaries of the law will soon become very blurred.