Legibility

When insider trading becomes a national security issue, not just a financial one

Disclosure: I run Kalshinomics.com, which may earn Kalshi referral fees. I may trade event contracts on Kalshi and securities on other platforms. Readers should consider this relationship when evaluating my analysis. For educational purposes only, not investment advice.

A near nightmare scenario for prediction markets — and potentially the US military, a US soldier traded on the plans to attack Maduro on Polymarket, which could have leaked intel and put US forces at risk.

He allegedly risked ~$33,000 and profited over $400,000. This is a lot of money for an individual but tiny in the world of financial markets. Possible and real insider trading cases have been breathlessly covered by the media as prediction markets have grown. But insider trading is not new, why the sudden interest when it occurs in prediction markets?

Legibility. When a corporate insider steals company information to make a trade, they generate profit for themselves and losses for their counterparty. But unless done in massive size, the market and public is none the wiser until an enforcement action hits years later. The insider has profited from the information, but it hasn’t necessarily leaked to the market, and definitely not to the public. But this information leaking could have real consequences outside financial markets, in this case specifically the lives of US soldiers. This is not simply theft.

It’s genuinely hard to “read” a stock price for information most of the time. There are many reasons for a stock to move, the classic response on Wall Street (that I have used many times) when a client asks why some name is up today is “more buyers than sellers.” People mock that line, but it’s not wrong! Short term that’s what often moves stock prices. Or news comes out that triggers an increase in fair value by traders, leading to….. more buyers than sellers.

But the basis risk between the prediction market and the event it resolves to is much more specific. Basis risk is the difference between the exact thing you want to bet on and what you can actually bet on. A corn farmer wants to hedge their specific crop, the CME corn futures contract is deliverable based on No. 2 yellow corn. If those prices are closely related, that’s a good hedge. But there’s almost always some basis risk. This is also why parametric insurance on something like a hurricane is a better fit for institutions than individuals. This type of contract might pay out “Will the wind speed in Miami hit 157 mph (category 5).” Wind speed is a good proxy for overall hurricane damage. But you care about your roof. Roof blows off and wind only hits 156? Out of luck. So in the past you might have bet on oil if you expect conflict in the Middle East. And now you can bet specifically on a conflict. The specific contract collapses the basis between your information and what you’re betting on.

Stock Prices - Low Legibility, Options - Medium, Prediction Markets - High

When a stock gaps higher, the reason may not be clear… is there news out? What type of news? Anything? Maybe it’s an obvious headline, maybe it’s a signal from alternative data, maybe it’s a fund executing a large buy order. The message is ambiguous. Options tell you a little more, what’s the likely timing of some event? How uncertain is it? What’s the probability distribution look like? But this requires expertise in pricing to understand, and again requires insight into what a stock price implies to be legible. But when a new Polymarket wallet bets big on an attack on Maduro, everyone knows what is being bet on. It’s legible to the public and the professional alike.

The week before conflict with Iran started in February 2026, you could bet on whether the conflict would occur on Polymarket. You could also bet on it via short-term out of the money call options on oil futures. There’s many reasons oil can move, and flow from speculators, hedgers, and dealers co-exists in that market. But at that instant, what was the biggest short term risk to oil prices, that had been driving oil prices higher over the preceding weeks? The possibility of a US attack on Iran. The most likely scenario that would cause those calls to be in the money was an attack. If you traded them, you were making a war bet on a CFTC-regulated platform. Normally, there’s a basis between what moves oil and a war contract. In scenarios like this, that basis collapses. But importantly, this probability is not legible except to oil option traders. None of them would have needed to check Polymarket to give you the probability of attack. Explicit bets on war or assassination are not allowed by the CFTC. But all markets are death and war markets to some extent. To the extent wars impact prices, traders will be attempting to incorporate these probabilities into markets, but there’s a basis between what they’re betting on and the actual conflict, vs the explicit and legible nature of the prediction market.

(As I mentioned, war markets are not allowed by the CFTC. I’m not endorsing the existence of these markets offshore. They exist. A politically popular objection is that they allow betting on war and death. I agree it’s distasteful. But let’s not fool ourselves, as long as markets have existed and war is important, it’s being bet on and will continue to be. It just hasn’t been legible to the public.)

This legibility is both strength and curse to these markets. To the extent these markets distribute informed probabilistic estimates of events we care about, that’s of incredible value to the public. When we suddenly provide legible warnings of an attack to geopolitical rivals, that’s far worse than an insider making an equivalent amount trading a stock.

How Legibility should affect market structure

Because some of these markets are important, and because the cost of insider trading can be much higher than counterparty losses, pseudonymous wallet-based market structures are a poor fit for the most sensitive contracts. You want KYC, market surveillance, and audit trails. Ideally, you want to identify likely insiders up front and prevent them from trading. You will not catch everything, but you can make abuse harder.

While war markets are currently not allowed in the US under the CFTC, legibility does not respect jurisdictional boundaries. If the market exists offshore, the information it reveals is still visible everywhere. If the information is anywhere, it’s everywhere.

A counterargument to this is the blockchain based system on Polymarket provides more transparency vs the trading on platforms like Kalshi. On Kalshi, trading is anonymous on the user level, but transparent at the exchange/regulator level. On Polymarket, the public can see wallets and trades, but tying those wallets to real-world identity is more difficult (but not impossible as shown in the Maduro case). This is a fair argument. The tradeoff is public transparency vs institutional accountability. And US trust in government is near an all time low. While the CFTC has been active on prediction markets under Chairman Selig, it has only one commissioner, and in 2025 had cuts in staff. It’s important it has the capacity to enforce. My bias is towards well-run institutions and consistent, capable regulators.

A strong counterargument to all of this is that the public benefit of legibility outweighs the cost. I agree generally with that sentiment! My argument is that legibility is not universally positive. Are there ways to create legibility where it’s desirable and avoid the costs? For this specific example - I’m not sure. Should this contract even exist?

Fear of insiders leads to a new attack vector

There’s another source of illegal manipulation I’d expect someone to try now that we’re attuned to checking unusual wallets for insider trading. The “tail wags the dog attack.” The source of this is the huge gap in liquidity between a geopolitical contract and other markets that care about that event. The liquidity in “Will US attack Iran” is tiny vs that of oil futures or equities.

If traders in traditional finance see prediction market prices as a good information source (which they often are), a bad actor could first put on a position in oil futures, then buy up a huge amount of a geopolitical contract that has an effect on oil prices.

But there’s no attack and no inside information - it is simply an attempt to convince traders to incorrectly incorporate this legible probability from the thin prediction market into a more liquid security. Oil spikes, they sell their position, having incinerated a few hundred thousand dollars to manipulate the prediction market, and made millions in the futures market. This is harder to catch, the “insider” looks dumb on the prediction market, and the trading is much less legible on the more liquid exchange. I wouldn’t be surprised to see this attempted. If I was a regulator I’d check for it, and if you’re a trader, keep some skepticism on mismatched liquidity scenarios like this that are unsupported by external information.

The legibility prediction markets bring to real-world events is their biggest strength compared to traditional financial products like stocks and futures. But this legibility has unique costs and requires thoughtful work from exchanges, their compliance teams, and regulators. My hope is that as these markets develop, more thought is put into which markets are listed, how the contracts are written, and the surrounding guardrails and market design.