The federal government and a growing number of U.S. states are clashing over the regulation of prediction markets.

The Commodity Futures Trading Commission, the federal agency that oversees prediction markets, on Tuesday filed a lawsuit against Kentucky over its efforts to crack down on Kalshi and Polymarket for what state officials allege are violations of gambling laws. Kentucky Attorney General Russell Coleman sued the prediction market platforms earlier this month, along with two other companies, alleging they offered illegal sports betting and gambling services. 

Including Kentucky, the CFTC has now initiated legal actions against nine states over their push to rein in prediction markets: Arizona, Connecticut, Illinois, New York, New Mexico, Minnesota, Rhode Island and Wisconsin.

In its May suit against Minnesota, the CFTC is seeking to block a law that would make operating, or helping to operate, a prediction market in the state a felony. 

What's behind the battle for control?

The legal tussles boil down to whether the federal government or the states have primary authority to oversee prediction markets, which allow users to bet on the outcome of sports, elections and many other events. 

The battle comes at a pivotal moment for companies like Kalshi and Polymarket, which have raised billions in venture capital, as prediction markets face scrutiny over allegations of insider trading and money laundering.

The CFTC says Congress gives it exclusive jurisdiction over the regulation of derivative markets. According to the agency, the Dodd-Frank Act, a 2010 law passed in the wake of the housing crash to tighten financial oversight, expanded its authority by giving it control over swaps, a type of derivative contract.

"The commission will continue to pursue litigation in any state that infringes on its federal authority," a CFTC spokesperson said in a statement to CBS News.

Jeffrey Alberts, a partner at the law firm Pryor Cashman and a former federal prosecutor, said there is legal ambiguity about whether the CFTC's jurisdiction extends to sports betting, which drives much of the trading volume on prediction markets. Over the last two years, sports have accounted for 80% of trading volume on Kalshi and 39% on Polymarket, according to Pew Research. 

But allowing individual states to apply their own rules to prediction markets could lead to a patchwork of regulations that chills innovation and stymies growth, he noted.

"We've often seen other countries where their fintech companies are able to beat ours, not because they're more innovative, but because we're kind of kneecapping our own industry by making them comply with 50 different regulators at the same time, which slows them down," Alberts said.

For their part, the states challenging the prediction markets contend that the platforms are breaking their laws by enabling illegal gambling. 

Advocates for stronger state oversight, such as the American Gaming Association, also claim the CFTC lacks the expertise to regulate prediction markets, particularly in sports betting, which has historically fallen within states' regulatory domain. Thirty-nine states offer some form of legal sports betting, according to CBS Sports.

"There's a very real question about how does this small agency effectively take on the role as a national sports betting regulator?" said Chris Cylke, senior vice president of government relations at the AGA, which represents the casino and gambling industry. "We believe the answer is that they can't."

States play a large role in regulating gambling and preventing addiction, Alberts said, noting that the Commodity Exchange Act (CEA) — the 1936 law that established the CFTC's statutory framework — wasn't designed to address those issues. 

"Congress didn't explicitly say that the CEA somehow converted the CFTC into a national sports gambling regulator," he told CBS News. "When you look at the purpose of the CEA, it's not to address things like addiction." 

Off to the Supremes?

Legal experts think the question of whether the federal government or the states should regulate prediction markets could end up before the Supreme Court, possibly as soon as next year.

Stephen Piepgrass, a partner at Troutman Pepper Locke who leads the law firm's regulatory practice, said the high court could ultimately divide control, giving states authority to regulate certain sports wagers, such as so-called prop bets, while allowing prediction markets to continue offering other sports-related trades.  

Congress also could provide clarification before the issue reaches the Supreme Court.

"We're lobbying for Congress to act on this, because I think fundamentally we believe this boils down to congressional intent. This is not what they intended," Cylke of the AGA said.