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After 20 years of water reform in Australia, the clear policy “winner” has been the cap and trade market-based instrument. Although widely promoted as an efficient tool for managing water, little critical attention has been directed to the legal and governance issues of water markets, including matters such as compliance and enforcement, water accounting, and the overall effectiveness of water trading. In response to these gaps, this article critically evaluates Australia’s cap and trade instrument, drawing on a review of the literature and new survey and interview data collected in New South Wales, Victoria and Queensland from government and non-government stakeholders. The findings reveal achievements, including: flexible responses to past and future droughts; efficiencies that contribute to economic and environmental benefits; and increasing trade and market functionality. Yet, the results also suggest cap and trade schemes are not functioning at the peak of their powers because of seven key flaws, namely: a lack of robust regulatory underpinning; limited accuracy in water accounting; challenges in addressing universality of impact and source; queries over environmental benefits; lack of accounting for wider social impacts; windfall gains; and limited operation across Australia. Some of these flaws are correctable, and the article pinpoints relevant areas for market policy reform. However, a number of the identified flaws require water law and policy to look beyond markets. The article argues that, in these areas, such as groundwater, complementary regulatory tools are needed to ensure Australia’s future water security and sustainability.