Exchange we can believe in

Betfair’s sports betting exchange generated revenues in excess of $300m last year, but critics still claim the product has never fully broken into the mainstream. “Ultimately, the concept proved too difficult for customers to grasp and whilst they made a lot of money and headway they couldn’t ever get the education piece over the line to become a mainstream product,” says Eoin Ryan, head of sportsbook product at European bookmaker BetVictor.

However, $325m in annual revenues is not a bad return for a ‘niche product’, and Betfair is looking to transplant its money-spinner into the US, where the combination of millions of sports and racing fans, a cottage industry of DFS pros and an army of casual stock market traders could provide uniquely fertile ground.

Of course, Betfair is not alone in recognizing the size of the US prize, and could face competition from a variety of players, including traditional UK exchange rivals Matchbook and Smarkets, technology firms like Microsoft which hold several exchange patents, and even the pro sports leagues themselves.

Of course Betfair is the clear favorite to establish a similar level of dominance in the US as it has in Europe, but as any horse bettor will tell you, there’s no such thing as a sure thing, and there are plenty of hurdles to be cleared before Betfair can pass the winning post.

Desert oasis

The initial opportunity for an exchange platform looks to be in Nevada, as the only state where sports betting is freely available. Several firms have patents on exchange-style wagering, including CG Technology (CGT), which is believed to be up for sale via auction in mid-April. Perhaps unsurprisingly, Betfair parent Paddy Power Betfair is rumored to be the favorite to purchase CGT, with fellow European giants William Hill in the running and Ladbrokes an outsider.

“There is for sure a future for exchange wagering in Nevada,” says Quinton Singleton, vice-president of corporate strategy and government affairs at NYX Gaming Group. “It’s just a matter of time before you see them [exchanges] launching.”

Singleton actually drafted exchange regulations for Nevada in his previous role at CGT, but says these have been shelved for the meantime due to “commercial reasons”.

As a result, there are no laws in place for exchange betting. “It’s a permissible activity but it’s not been addressed in practice yet,” Singleton says. “I was writing the regulations last year because I wanted to provide a clear framework for exchanges in Nevada and I wanted to be clear that anyone could use it, whether they were books, bettors, mutual funds; they could all access that liquidity.”

However, no-one has yet taken the plunge, Singleton believes due to the lack of liquidity in a relatively small market. But there still appears to be two routes round the liquidity issue for exchange operators. Firstly there is the potential for interstate or international liquidity compacts. Nevada and Delaware already share poker liquidity for example, while Betfair’s New Jersey Exchange pools liquidity with the UK.

“If they’ve established that precedent, that’s great,” says Singleton. “Shared liquidity could solve the issue and based on those precedents I think it could be done.”

Another route to market for exchanges could be as a B2B provider, possibly the route Betfair is considering through a CGT purchase.

“Plugging in market-making via an exchange and making it available on a B2B basis for land-based casinos is a relatively simple exercise and a good way to get ‘on the ground’ in the US, and also pick up a portfolio of 20 plus patents and filings,” says Liam Casey, a gaming consultant who consults with betonexperts.

“For sure there is a B2B opportunity,” agrees Singleton. “They might provide a different type of odds but an exchange is a great ongoing indicator of where the market should be. That type of data is a great commodity.”

As Betfair put it in its recent annual report: “Our betting exchange augments our pricing expertise [in sportsbooks] and allows the hedging of unwanted liabilities.” However, Betfair declined to comment for this article.

Further afield

Outside of Nevada, the same law that bans traditional sportsbooks – namely PASPA – will likely apply to sports betting exchanges, although it has not been officially tested in courts.

It means exchanges will have to look elsewhere in the short term, but fortunately there is already a model proving to be successful in attracting savvy investors looking to trade on their information.

Arguably the most visible ‘gambling’ exchange in the US is events-driven, in the form of PredictIt, a descendant from platforms like InTrade which ask traders to predict the outcome of political events.

InTrade famously predicted the outcome of 49 of 50 states in the 2012 presidential election, only to be shut down weeks later, when the Commodity Futures Trading Commission (CFTC) filed a civil lawsuit against it, essentially labelling Intrade an unauthorized exchange.

PredictIt learned from its predecessor’s mistakes however and has a No Action letter from the CFTC, which allows it to operate a “not-for-profit market for the trading of event contracts”.

The CFTC has also granted PredictIt permission to offer markets on five economic indicators; things like unemployment levels for example, and says it is constantly engaged with the regulator to ensure its legal standing. The platform has no plans to start offering markets on sports, because its focus is on the education and research benefits of the exchange – something which is also stipulated by the CFTC.

Firms looking to launch their own event exchange would likely have to comply with similar restrictions designed to cap profit – markets are limited to 5,000 traders per event for example and each trader limited to $850 per market.

A PredictIt spokesperson declined to comment on the profitability of the platform, but the firm charges 10% commission on winnings and 5% commission on withdrawals, and saw almost 500 million shares traded in 2016 alone.

The platform is backed by the Victoria University of Wellington and whether regulators would allow a more clearly commercial operator to set up an event exchange without greater fees and regulatory oversight is still unclear.

Is there a market?

But will a US audience take to exchanges the same way Europeans have? They already are to an extent, according to Ryan Rodenberg, a sports law professor at Florida State University, who sees many similarities between DFS and exchanges.

“The way head-to-head games in DFS are structured is very similar to an exchange wager,” Rodenberg says. We have two people going against one another based on their opinion on a sporting contest, with the site taking a commission for facilitating that.

“And FanDuel and DraftKings have been phenomenally successful in encouraging people to do that – they have created a market as big as the Nevada legal sports betting market with $4-5bn turnover.”

The similarities extend beyond the core concept as well, with both sectors giving birth to a whole cottage industry of professional players who use technology to gain an edge over recreational players, and who provide the all-important liquidity.

The fact that DFS has already spawned this ecosystem in the US is a positive sign for exchanges, Rodenberg suggests. “Certainly Americans have the appetite for that peer-to-peer transaction,” he says.

Racing ahead

Elsewhere, Betfair would argue that its experience with its New Jersey Exchange, which launched last May, is proof of an existing appetite, with around $1m a month being wagered through the site.

The prospects for expansion to another state are also looking good, as Betfair claims 70% of New Jersey Exchange players were not previous customers of the advance deposit wagering network in the state, lending weight to its claim that it is bringing new money to racing.

California is likely next on the list where Betfair has approval to launch an exchange and agreements in place with several tracks.  Betfair US CEO Kip Levin said the company is continuing to work toward legalizing the betting form in more states, with the debates over DFS legislation acting as a “foot in the door” for exchange wagering.

And the crossover between the two extends beyond a regulatory push as Levin, like Rodenberg, says DFS players are the perfect target for exchanges.

“If you take a customer that’s used to daily fantasy and is playing at a high volume in daily fantasy, and you put a typical ADW site in front of them and you put the exchange in front of them, they will gravitate to the exchange and understand it,” Levin said.

He also predicted a slow but steady march to expansion, adding: “I think so far everybody wishes the volumes were higher but they’re encouraged by the metrics. It’s pretty analogous to the early days of ADW—sort of that one phase at a time, with questions about whether this is going to be good, and winning folks over one step at a time. We’re still going through that early progression and process with this.”

The competitors

So who will be the players in the future battle of betting exchanges? Betfair of course tops the list, and is the only company to have yet made its move with its New Jersey Exchange for horseracing. Matchbook, considered to be the second biggest exchange in the UK, said it had no immediate plans for the US, but was keeping close tabs on sports betting progress.

A spokesperson told EGR NA: “The US market is an exciting one for our sector and one that Matchbook certainly keeps an eye on. With its strong offering across horseracing, European and US sports, any market that becomes available is an attractive proposition, but presently, Matchbook is focused on building brand equity within its key licensed markets, such as the UK and Ireland.”

Smarkets – and its American CEO – is also eyeing the landscape with interest, having recently opened an office in Los Angeles. Jason Trost suggests the pathway into the market for his firm could be through event trading, as PredictIt, rather than traditional sports betting, in an effort to tap into the millions of ‘casual’ traders who keep a close eye on the stock exchange.

“While widespread sports betting isn’t common in the States, trading certainly is and as we continue to grow we are more likely to target those traders with our platform if legalisation gains more traction, rather than bettors,” Trost says. “I want to take event trading to the masses and have Smarkets be the leader in this field, rather than more traditional sports betting.

“Savvy, intelligent bettors looking for value will naturally be drawn to exchanges because of the lower margins, and we should be especially well-placed to appeal to them with our low commission ideals and focus on betting education,” he adds.

Trost struck a more pessimistic view on sports betting, adding: “At the moment we are keeping an eye on the news around legalization, but it still feels a few years away. We have just opened an American office, but that’s more because of the engineering talent we now have access to, rather than actual betting in the US.”

New faces

Interestingly, the nascent nature of the exchange business in the US means we could also see some outside runners join the race

“Will the sports leagues want to get involved with a platform of their own?” Rodenberg asks. “I think we will see more support for sports betting from them if there is a monetary hook and it’s not unfathomable the NBA sets up its own exchange using its own data, and tells customers, ‘come and play with us, you can trust us, we’re the NBA’.

“We’ve already seen them invest in DFS companies, so this isn’t a huge step. New exchanges spring up all the time. After Flash Boys [a Michael Lewis book about high frequency trading] a group of people got together and set up an exchange that didn’t allow HFT. It’s not that uncommon,” Rodenberg adds.

The future of the exchange marketplace is so wide open, in part because of the free-for-all on patents for the concept. Betfair has an American patent titled ‘Betting Exchange System’ but as one source, who requested anonymity, put it: “Patents in the US are clearly under assault right now.”

A 2014 Supreme Court decision in Alice versus CLS Bank court ruled that an abstract idea – such as exchange betting software – does not become eligible for a patent simply by being implemented on a generic computer.

In essence, the decision made it much easier for companies to create similar concepts to rivals without infringing copyright.

“Betfair has an exchange patent, but how valuable is that?” asked the source, who has a legal background. “Regardless of anyone’s patent portfolio, they’re going to do it [launch an exchange] and deal with the issues after the fact. This is 100% coming.”

As Betfair has proven in Europe, the first–mover in a liquidity driven market has a massive advantage, and the firm looks intent on replicating its success via the slow expansion of its racing exchange, or a push into Nevada via acquisitions.

However, the firm is faced by a variety of firms that may benefit from local knowledge and brand recognition, while traditional exchange rivals aren’t starting from the same deficit as abroad.

Who will win the battle for dominance in the exchange space is still undecided, but the fact there will be such a battle seems undeniable.