Swinging for the fences: Could US sports betting ever become a financial asset class?

The New York Stock Exchange went hypersonic in the nineties. The volume of shares traded annually went from around 40 billion at the start of the decade to more than 265 billion by the end of the decade, an almost seven-fold increase. The market value of all those transactions also exploded but, even more so, climbing approximately 2,000% over the 10-year span. And it was a rise being mirrored across the financial markets, with equities, options and securities all enjoying meteoric growth.

So, what happened? Underpinning the growth was of course technology. Internet traffic around the US dramatically increased around the middle of the decade and small retail traders suddenly had the same access to real-time pricing as professional brokers through online brokerage firms like E*Trade and Ameritrade. Quantitative tools to help retail customers find and place trades sprang up everywhere. The word “day trader” literally entered the lexicon while the tech bubble – it was a bull market rather than a bubble at the time of course – created a kind of frenzy of digital gold digger hunters, looking to strike pay dirt. The explosion is not too dissimilar to the crypto frenzy of recent years but some see a rather different parallel happening in the not too distant future.

There is a school of thought – a niche one currently it must be said – that the US sports betting market is heading for a similar kind of explosion, culminating in a betting market where financial institutions and millions of retail investors trade billions and even trillions on sporting events daily.

“There could become a new investment ecosystem around [sports betting],” said Paul Kedrosky, a management partner at venture capital firm SK Ventures, in a recent interview with marketplace.org.

“It’s definitely a pie in the sky thing but it’s the thing that I feel most confident that’s going to happen in the longer run…. Imagine being able to carve off a small fraction of your portfolio and some of it goes into venture capital, private equity, or whatever else and some of it could also go into sports betting.”

It’s an attractive proposition because sports betting is entirely uncorrelated to the wider market. If the S&P 500 plunges, your bet on the New York Yankees doesn’t care. As Gregory Wolfe, a former options trader, puts it: “When the fed sneezes, every financial market gets a cold. Except sports that is.”

Wall Street sign, downtown Manhattan, New York City

It’s such an appealing idea that Wolfe has built an entire trading platform based on that exact premise. Wolfline Sports aims to provide financial-style analytical tools to investors looking at sports markets. As they say in a gold rush, the people who get rich first are those selling the shovels and Wolfe is aiming to do just that.

As he sees it, the betting market is currently undergoing a similar technological revolution to the point that exchange platforms can sustain massive volume of transactions, and retail traders will soon be able to get their hands on a variety of quantitative analytics products that will fuel their decision and subsequent trades.

“The opportunity here is huge,” says Wolfe. “It’s what happened when retail traders got hold of education tools and analytics but multiplied by 20. There’s six trillion dollars traded daily on foreign exchange and I don’t see why sports can’t match that.

“In my world, it’s understood that bets are essentially securities. Once that’s widely accepted, sports is going to show up on the drop-down of every brokerage in the world. It’ll simply say stocks, futures, commodities, metals, and then sports.

“From the institutional side you’re going to have hedge funds investing here. Then on the retail side you’ll have millions of people taking this on. Your granny in Omaha will log into her E*Trade account, use the analytics and start trading.

“I’ve literally had this conversation verbatim with people in very high levels in the traditional financial industry and they are very interested.”

Crossover

As the sports betting market grows more mature around the world, there is indeed a growing cross-pollination between sports and finance. The tools needed to succeed in both – namely prowess with quantitative analytics – is broadly similar, and there have been more and more examples of traders crossing the aisle, so to speak.

Nick Smith was a trader at Citi Group and Goldman Sachs in London before leaving the latter earlier this year to set up his own sports betting operator with a fellow financial trader from Goldman and a third partner from the betting world.

According to Smith, several Goldman colleagues have made similar moves – using their analytical skills and tools to either bet for a living themselves or joining betting syndicates.

“Fundamentally all exchanges are the same thing,” says Smith. “And people from Wall Street don’t care what they’re trading, they go where they can make the most money and where it’s the easiest to make that money.”

Nowadays, in Europe at least that’s increasingly becoming the betting markets. “Financial markets have had the best part of a hundred years of academics and quants and millions of people working out how to make money and build models to beat the market,” Smith says. “And it’s incredibly difficult to make any money there. The margin has been stripped away.

“Sports on a relative scale is massively in its infancy. It’s like going back to the seventies and there’s so much low-hanging fruit. So, people are thinking ‘what’s the point in busting my balls on Wall Street trying to make 1%, when I can apply the same time and resource to the sports betting market and make a lot more, more quickly?’ And as people do that, liquidity grows. People are plugging into APIs and pretty significant pools of money are starting to form.”

There is however a significant difference between individual traders finding easier paths to profitability in the betting markets, and giant hedge funds with billions under control doing the same. Simply put, sports liquidity has never reached the levels of the equities or options markets even in markets where its matured, and there appear to be structural reasons why, suggesting that predictions of explosions in the US are somewhat fanciful – even putting aside the current patchwork of state legislation and federal laws like the Wire Act that prohibits nationwide liquidity sharing. Assuming, optimistically, that the Wire Act is scrubbed from the record books sometime in the next 10 years – could sports become a realistic alternative investment vehicle?

Glass ceiling

“It’s simply not feasible to me,” says Scott Schectman, president of Longitude, the pool betting technology arm of Nasdaq.

“There’s a tendency to look at sports betting in the US as a brand new moment, which locally it is, but globally this is a very mature business. It’s not as though global capital markets are not aware of their local sports markets, and there’s real reasons you don’t see this developing in Asia and Europe and those same reasons apply to the US.”

The main sticking point in Schectman’s view is the cap on profits. While traditional markets are underpinned by tangible assets which grow every year, there is no such underlying value and growth in sports. In other words, everyone can theoretically make money in financial markets if the market is growing 8% a year but in sports the winners get paid by the losers. And it’s unrealistic for the losers to lose the trillions each year needed to sustain a massive market.

“There’s just a dramatic difference in scale, “adds Schectman. “Even the largest betting syndicates are dwarfed by most asset managers. The whole ecosystem that fuels the capital markets has such a diversity and range of people that simply just doesn’t exist in sports. You just don’t have multibillion dollar pension funds in the betting market to take the other side of your trade. There’s only going to be as much institutional liquidity as there is retail liquidity to support it. The same as it is in the UK, Australia, Europe and Asia.”

It’s a view echoed by Peter Webb, one of the best known Betfair traders in the UK, who started using the exchange platform the week after it launch. “I always thought by now we’d be trading millions on every race, but it’s just never really happened,” says Webb. “There’s only so much money in the losers pool.”

Peter Webb also points to the fragmented liquidity and high velocity of sports markets as a reason that liquidity never gets really huge. “Sports as an asset class sounds really appealing, but betting markets are structured differently. Betfair must have matched bet turnover of £60bn or £70bn a year but that’s broken down into tens of thousands of events so it becomes quite small in the scheme of things. If you had ten thousand pounds and put it on a race, you can do it again in 10 minutes.”

More than one way to skin a cat

It’s perhaps telling that some of the most successful bettors in the world almost invariably have found other ways to use their expertise in pricing events other than simply betting. Renowned football bettor Matthew Benham is known to have a major investment in betting exchange Matchbook, racing guru Zeljko Ranogajec has links with pool betting firm Colossus Bets, racing syndicate The Woods Group has multiple interests in betting operators, and the list goes on. In short, these punters all found ceilings to profit-making in betting markets alone.

From a different perspective it’s even a reach to suggest that giant hedge funds could enter betting markets where these participants are already active and have been perfecting their craft for decades and simply outsmart them. Perhaps more likely is the story of Stratagem, a UK-based betting hedge fund, founded by another former Goldman trader, that promised to use AI to beat the sports betting markets. It did not.

Base case

Smarkets founder Jason Trost perhaps splits the difference between the bulls and the bears, suggesting that a mature US betting market could feasibly see a massive explosion in liquidity thanks to millions of new retail customers, and still never become big enough to appeal as an investment opportunity to hedge funds and asset managers.

“Even if it went 10x it’s still low volume compared to finance,” Trost says. “You already see some finance people doing sports stuff but it’s going to take a long time, if ever, to become the size of the bond market for instance.”

As for whereabouts this potential explosion in sports trading will take place, Trost is unsure whether the tech will come from companies like his own, Smarkets, or the likes of Nasdaq and Ameritrade.

Jason Trost, Smarkets CEO

“It could be either or it could be both,” says Trost. “The way you see the financial industry, some exchanges are good at x and some are good at y. But the growth will come from somewhere. There’s no question this industry will continue to mature and that means more liquidity and lower bid/offer spreads. In 10 years this won’t be a huge margin game. If we don’t do it, someone else will.”

Ultimately, talk of sports betting becoming a true alternate asset class is indeed far-fetched in the near and medium term, starting just with the level of regulations that would be needed to facilitate it. Next, the thought of billions being traded on a single sporting event is somewhat perverse – regulators would likely have concerns about match-fixing with the rewards so staggeringly high.

“Because of the unique position of sports in America and the overwhelming concern about integrity, having financial institutions with billions under management making their own markets is something that may be considered at-risk for tampering,” says Joe Brennan, CEO of SportAD.

“Wishing the market to “explode” is not the same as having the necessary conditions to permit it,” Brennan adds. The fragmented nature of the market and the sheer amount of losing money needed to pay the winners also presents a probably insurmountable obstacle. Ultimately the venture capitalists and financial types looking for an uncorrelated investment might be better served getting a personal betting exchange account and getting stuck in rather than waiting for the explosion to arrive. Of course, once they do they might find that generating steady returns from a sports betting portfolio is rather easier said than done.