Former CFTC Commissioner: Wall Street has used these financial contracts for decades. Now a goat herder does too

A goat herder in Northern California just did something more typical of a Wall Street investment bank – hedge risk with derivatives.

Tim Arrowsmith’s labor costs were about to more than triple after a state wage exemption policy expired on June 30.

No insurer would cover that risk.

No futures contract existed for it.

So he paid $50,000 for a contract on Kalshi that pays him $500,000 if Sacramento doesn’t fix the rule by October 1.

Now, if Sacramento does fix it, his labor costs stay the same and he’s only lost $50,000.

If they don’t, he’ll have $500,000 to cover the increased labor costs.

Because of prediction markets, for the first time ever, small businesses like Arrowsmith’s have access to risk management tools that Wall Street has used for years.

Until more recently, most Americans didn’t think about derivatives markets, but those markets and instruments have let farmers, oil producers, financial conglomerates, and entire sectors of the economy keep prices and costs more stable by transferring risk to someone willing to carry it.

They also broadcast valuable information about where risk is headed to better inform decision-making.

US derivatives markets have helped create and sustain the greatest economy on earth.

The primary reason is that the design of the Commodity Exchange Act (CEA), the law that governs those markets, has led to the most innovative and broad set of derivative instruments in the world, traded on the most well-regulated markets anywhere.

The CEA recognizes that anything that can pose risk to people and businesses, whether it be a physical good, a financial concept, or an actual event, is a valid underlier for a derivative listed on a federally regulated marketplace.

While prediction markets’ explosive growth is a recent phenomenon, event contracts aren’t new and are just another prior innovation within that framework, not a departure from it.