By Beth Carney Britain's online betting exchange Betfair is often likened to an eBay of sports betting. But founder Andrew Black prefers another analogy: the New York Stock Exchange. "It's an order-driven trading platform," says Black, a former equities trader and software developer, who once spent a year gambling full-time. "It does a lot of awful lot of work behind the scenes."
These days, Betfair is doing more behind-the-scenes work than ever. While poker's phenomenal popularity has been by far the biggest growth stimulus in online gambling, the relatively low-profile business of betting exchanges is the other sector that's rapidly expanding (see BW Online, 2/25/05, "Online Poker: IPOs in the Cards?"). The concept behind them is simple: eliminate bookmakers and create a way for people to bet with one another on the Internet.
Betfair -- which doesn't knowingly take bets from the U.S., where online sports betting is illegal -- is the biggest betting exchange by a wide margin. The four-year-old company has 300,000 registered users, and matches 2 million bets a day, although many of those represent the same users trading in and out of positions. Last year, it reported about $126 million in revenue, up from $11.5 million in 2002.
SUPERIOR ODDS. How does it work? On Betfair, bettors -- what the Brits call "punters" -- place bets on sporting events according to odds that have been determined by the market. The odds change over the course of the day, or even the course of a game, depending on supply and demand, much like prices change in a stock market. Users who do not like the current odds can offer their own, which exist as a standing order until another user takes the other side.
The system isn't as simple as betting with a bookmaker and can be confusing to the inexperienced. But the advantage to users is that the odds are generally superior to those offered at traditional bookmakers. The commission Betfair charges of about 3% of winnings is less than a bookmaker's take, although the latter's cut isn't obvious because it's built into its odds. Unlike bookmakers, betting exchanges don't take risk, because they fill only the bets that other customers will match.
"They basically replace the middleman," says Leighton Vaughan Williams, director of betting research at Nottingham Trent University's business school. In the long term, he predicts, "one could see a day when conventional bookmaking is replaced by betting exchanges."
"UNFAIR COMPETITION." Sports betting and gambling in Britain is a huge business. Betting shops are common fixtures in retail districts, and the three largest publicly traded bookmakers -- William Hill, Ladbrokes (which is part of the Hilton Group), and Stanley Leisure -- last year together reported taking in the equivalent of $2.5 billion on their gambling operations. They have waged a campaign against Betfair and other exchanges' entry into the market.
Although Betfair, like all bookmakers, pays 15% tax on profits, plus an additional 10% levy on horseracing profit, the traditional bookmakers argue that users of the exchange who "lay" bets -- or bet that a particular team or horse loses -- are in essence acting as bookmakers and should also be taxed. "We have to build that 25% into our odds," says Tom Kelly, chief executive of the Association of British Bookmakers. "We say that's unfair competition."
More damaging to the reputation of betting exchanges has been the bookmakers' contention that the business model threatens the integrity of sport. Because betting exchanges offer people a way to bet that a competitor, such as a horse, will lose, they create an opportunity for fixing races, the bookmakers claim. In September, police arrested 16 people, including three jockeys and a trainer, in an investigation of horse-race fixing in which Betfair's records provided evidence.
"THEY GET CAUGHT." Fears that exchange betting would corrupt horseracing have dogged Betfair's effort to acquire a license that would allow it to advertise its services in Australia, the site's second-biggest market after Britain, even though the company does no marketing.
Betfair, however, dismisses the charge that exchanges encourage fraud. It shares information with sports bodies, and its managers say that unscrupulous users who bet through the exchange are much more likely to be detected than if they pay cash at a High Street betting shop, thanks to the recordkeeping. "They get caught because of us," says Mark Davies, Betfair's managing director in charge of communications.
At the moment, bookmakers' objections hardly seem to be fazing the punters. Betfair continues to grow, and industry sources estimate that about 40 different betting exchanges have sprung up in the past four years, most based in Britain. Although current users tend to be relatively sophisticated -- either frequent bettors or financial-market traders -- those in the industry say the exchanges have the potential to appeal to a wide audience.
SPANNING THE GLOBE? TradeSports, a "trading exchange" whose model is similar conceptually to a betting exchange but more closely mimics a stock exchange, has seen its membership nearly double in just over a year, from 23,000 at the end of 2003 to 45,000 today. The Ireland-based site allows its members, 85% of whom come from the U.S., to buy and sell contracts on events ranging from the Super Bowl to who'll win the Oscar for best director. Each event is priced according to what members see as its likelihood of happening.
"People understand risk. They understand buying and selling. Whether they're sports bettors or financial-futures traders, they're always looking at liquidity at the right price," says Mike Knesevitch, TradeSports communications director.
As the biggest online betting exchange, Betfair has an advantage over its competitors, because it has the most users and, therefore, the most liquidity. Now, 75% of Betfair's customers are British. The company's worldwide expansion will depend in part on clearing regulatory hurdles in various countries that restrict gambling. Because of its size and the Internet's reach, however, Davies says: "We are the first bookmaker that has the chance to become a really global brand." Whether it will is anyone's bet. Carney is a correspondent for BusinessWeek Online in London