Variant: Reflections on Insider Trading in Prediction Markets

Authored by: Daniel Barabander, Variant Chief Legal Counsel and Investment Partner

Translation: @GoldenFinance xz

Market Insider Trading has recently become a hot topic of discussion.

Many founders have noticed that before major events, unexplained wallet addresses suddenly start trading, prompting them to question: is there illegal activity involved? But to answer this question, we need to step back and understand how insider trading actually works—something most people are not familiar with.

If you consult most lawyers about insider trading, you’ll hear a lot of obscure legal terminology. They might mention “fiduciary duty,” “classical theory,” “misappropriation theory,” “information disseminator,” “information recipient,” “insider,” “outsider,” and so on. When trying to apply these concepts to emerging fields like prediction markets, even they can become confused.

(This is not legal advice; for specific issues, please consult a professional attorney.) Here, I want to provide a simplified analytical framework to explain my general understanding of insider trading and how I believe it should apply to prediction markets.

Insider Trading = a form of Fraud

The first thing to understand about insider trading is that the law regards it as a form of fraud. Like all fraud, insider trading involves deception carried out for personal gain. This deception usually stems from violating explicit or implicit promises regarding the “use of restricted information.” In reality, there is no separate “Insider Trading Law”; rather, anti-fraud rules apply to insider trading. The main difference between insider trading fraud and typical fraud is that the promises involved are often more subtle, making them easier to breach.

A typical pattern of insider trading is: an employee breaches their promise to their employer by trading stocks using material non-public information. Whether you agree or not, working for a company implies an implicit promise (established by law) to act in the best interests of the company and its shareholders. This promise is likely explicitly included in the employee handbook you agree to upon hiring. When an employee uses material non-public information to buy or sell the company’s stock, the counterparty shareholders are at an informational disadvantage; exploiting this asymmetry for trading constitutes a fraudulent breach of the promise to shareholders.

What many overlook is that this is just one manifestation of insider trading. Anyone who fraudulently breaches explicit or implicit promises in trading could be engaging in insider trading.

For example: suppose an employee learns that their company is involved in a merger. The employee knows that typical insider trading scenarios are prohibited, but tries to “cleverly” use this material non-public information to buy stock in the company’s biggest competitor, expecting the stock price to soar after the announcement. Even though the employee has no implicit loyalty obligation to the competitor’s shareholders, this could still constitute insider trading. The reason is: the employee has, through company policies, confidentiality agreements, or implicit loyalty obligations, promised their own company that they will only use confidential information for legitimate business purposes. Using that information to trade the competitor’s stock clearly breaches this promise. Therefore, the employee can be deemed to have fraudulently breached their promise, involving insider trading.

Promises are at the core

Promises are at the heart of the issue. Suppose someone overhears two investment bankers loudly discussing a pending merger during lunch. Recognizing the target company, they leave the restaurant and trade that company’s stock before the announcement. Although this information is clearly material non-public information, such conduct usually does not constitute insider trading. Because the trader did not make any explicit or implicit confidentiality promises to the bankers, nor have any implied obligations to the company or its shareholders. The bankers might have violated their own duties by careless talk in public, but if the trader did not fraudulently breach any obligation, there is no fraud—thus, no insider trading.

Anyone who fraudulently breaches explicit or implicit promises in trading could be engaging in insider trading.

From the perspective of “fraudulent breach of promise,” we can correct a common misconception: insider trading is not limited to securities markets. Conversely, similar issues can also occur in commodity markets (including derivatives). For example, a Cargill derivatives trader learns that the company will purchase a large amount of wheat, and then uses their personal account to trade wheat futures in advance. This behavior is very likely to constitute insider trading. In this case, the trader has, through company policies, confidentiality agreements, or job responsibilities, promised to use confidential information solely for Cargill’s business purposes. Their personal trades constitute a fraudulent breach of that promise. Conversely, if the trader’s role includes executing trades on behalf of Cargill before procurement, then it would not constitute insider trading—even if they act based on material non-public information (such as knowledge of the company’s planned market transactions)—because they are authorized to act in that capacity, and no fraudulent breach of promise occurs: they owe no implied obligation to other futures traders, and using that information for their authorized duties is permitted.

Prediction markets also apply

What does this mean for prediction market traders? My core view, perhaps disappointingly simple, is that the law itself does not change. Fraud remains fraud, and legal rules are flexible. The key question always is: does the trader fraudulently breach a promise through their trading?

Therefore, if a Tesla employee learns of the Q4 financial data and uses that information to trade in a prediction market asking “Will Tesla’s Q4 earnings exceed expectations?”, it is very likely insider trading. This conduct constitutes insider trading either because the employee breaches their promise to Tesla shareholders or violates confidentiality agreements or other commitments prohibiting the use of company secrets for personal gain. But if the same employee then trades in a prediction market asking “Will the growth rate of US electric vehicle charging demand over the next two years surpass gasoline demand?”—using only publicly available EV adoption data and industry expertise accumulated over years at Tesla (not internal plans)—then it probably does not constitute insider trading, because they are not misusing confidential information or breaching any promise.

However, prediction markets will push the boundaries of law and test whether it can adapt or be broken. Traditional markets are usually tied to specific companies: securities markets directly related to a company (like Tesla’s Q4 earnings), commodity markets indirectly related (like Cargill’s wheat procurement). This is crucial because companies are often the source of confidentiality and limited-use promises—these promises (whether implied by law or explicitly through confidentiality agreements, policies, etc.) form the basis of insider trading liability.

Prediction markets expand the scope of tradable assets (making nearly anything tradable), broadening the sources of valuable insider information, often involving scenarios where the existence of relevant promises is highly unclear. This is especially prominent in no-permission or opinion-based markets, which often lack any related company.

For example: suppose a high school has a prediction market for “Who will become prom king?” Your friend, the most popular person in class, privately tells you they cannot attend the prom. If you trade based on this information, does it constitute insider trading? The legal issue still hinges on whether you fraudulently breach a promise, but in this context, any such promise would need to be implied from your relationship or the information disclosure scenario, rather than from explicit obligations or formal agreements with a company. This makes insider trading litigation very difficult.

Legal boundaries will soon become very blurred.