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Revolutionary Bets

Betfair, a peer-to-peer online betting service system, has removed the middleman from the equation and taken the United Kingdom by storm.
Michael Kaplan
From the Print Edition:
Sharon Stone, July/Aug 2004

(continued from page 1)

Gamblers love to talk about the better way. Everybody has an opinion on the better way to run sports betting, the better way for casinos to divvy out comps, the better way for poker tournaments to be organized. Often the ideas make sense. Invariably they favor players. But rarely do these brainstorms go beyond mere verbiage. That is part of what makes Andrew Black's innovation so exceptional.

Rumpled, bearish and intensely focused, Black is a London-based computer programmer and stock trader who's enjoyed stints as a professional gambler. Like a lot of pros, he was frustrated by the cost of dealing with bookmakers (in Britain, commissions, or the vigorish, can be as high as 20 percent) and the rigidity of the sports-betting system. Bookmakers offer odds or a line and you have to take it or leave it. There's no room to offer a different price the way you can in, say, an equities market. As a result, says Black, "It's almost impossible to make money betting on horses in the United Kingdom. If you wanted to bet four horses in a race, you couldn't because the margins were so bad"—in England, most horse betting is done with legal bookmakers rather than through the track's parimutuel system, and bookies build profits into the odds they offer. "It was a real mug's game. Even if you were 10 percent better than average, you would lose. The only way to win [with the bookies] is if you have access to very good information."

In the late 1990s, Black was living a couple of hours outside London and working as a programmer for GCHQ (Government Communications Headquarters), Britain's equivalent of the CIA. He had sworn off gambling full-time. His hours were reasonable—9 till 5:30—and his wife was in London most of the week, working as a lawyer. Black had lots of time on his hands and devoted a good chunk of it to thinking of the better way to wager. That was when he had what he calls his "eureka moment": create an exchange for sports bettors, through which they can buy and sell positions and establish prices based on the attractiveness of particular wagers.

After five days of round-the-clock code writing, he had a prototype software program. That was easy. However, finding financial partners proved more challenging. "I was a very poor salesman," admits Black. "I remember explaining it to one guy and telling him that it's a 100-million-pound idea. His eyes glazed over."

But when Black happened to bump into an acquaintance, J.P. Morgan derivatives specialist Edward Wray, at a cocktail party, the response was much different. "The product is very simple, and the risk of leaving Morgan, in 1999, to set up a betting exchange didn't appear huge; I figured that if it didn't work, I could always go back to derivatives," says the trim, clean-cut and buttoned-down Wray. "A year later [after the 2000 stock market decline], I realized that this wasn't the case. By then, though, I was so enthralled with this project that there would be no going back."

That project has grown into Betfair, a revolutionary system that has taken gambling by storm in the United Kingdom. It is a peer-to-peer betting service, which works online and allows bettors to wager with one another rather than with a bookmaker. This takes the middleman—the bookie—out of the equation. Lines are set by the gamblers, with people logging on to Betfair's easy-to-navigate site and offering odds or point spreads, hoping for takers. Let's say, for instance, that the Dallas Cowboys are playing the New York Giants and you think the Cowboys should be favored by four. You post that you are willing to give those points. If somebody else on the site wants to make the bet, they will be matched against you and the wager is made. This happens with split-second timing, and, of course, it's anonymous; you don't know with whom you're betting. Everybody has funds, in the system, to back their wagers, and transactions are reconciled immediately after the game is completed.

The incentive to offer more attractive deals to the other gamblers—let's say, giving five or six points instead of four—is that you will get your bet taken quicker. This makes for a more efficient market, as gamblers, rather than bookies, who have ulterior motives (like balancing their books), refine the numbers. As used by straight-ahead bettors, who simply want to place wagers, Betfair allows for the negotiation of more favorable odds and lower commission costs (2 to 5 percent per bet) than those charged by bookies.

For sophisticated players, it becomes considerably more interesting. "There are those who use Betfair for trading their positions," says Black, explaining that he has devised the system to function just like an equities market. "If you back a horse that is 10-1 and lay it [bet against it] at 8-1, you can't lose"—you have essentially bought low and sold high, a strategy known as middling. "If the horse wins, you make the difference between the two wagers. And you can position yourself so that no matter what happens, you make money: you back it for 50 quid and lay it for 55 quid. That way, if you lose, you win five pounds. If you win, you walk away with 60 pounds. That's what we call a green book." But, as with the stock market, there is a potential downside: "The danger is that you can get into a position and not be able to get out of it because the price keeps going further and further down."

Only 20 percent of Betfair's customers are drawn to this rarefied form of wagering, and it has attracted a coterie of mathematically inclined players who've left their jobs in the city for a run at professional gambling. Such is the case with John Tuohy, a former IT consultant who's gone from being a regular day-to-day punter, with a 9-to-5 job, to gambling full-time on Betfair. He's a jovial guy, sitting on a couch in the study of his luxe waterfront high-rise apartment, watching races on TV and casually punching wagers into his computer.

Tuohy does a lot of the middling that Black describes above, but he's also found a particular edge for himself in running betting, which is wagering on a race after the horses leave the starting gate. Unlike bookies in the United States, Betfair allows gamblers to wager on sporting events up until the final seconds of play, and it has created advantages for gamblers who can quickly process ever-fluctuating information. "I'm good at it because I've spent a lot of time in betting shops during my youth," Tuohy says, half seriously, as he locks in a couple of middles for an upcoming race. "One secret is that you watch the jockey instead of the horse." Minutes later, as a race goes off, Tuohy nimbly punches at the keyboard, laying out fresh odds, backing a winner, and taking action on losers long before they hit the homestretch.

This race nets him a bit of pocket money that, over the course of a week, can add up to something substantial. He notes that his best and worst Betfair days swing between wins and losses of £5,000 (about $8,850). "I probably made the same amount from Betfair as I did, the year before, from the IT work," says Tuohy. "Gamblers think this is boring, but it's better than spending a lot of time working in an office. It is very much like day trading." Tuohy lets this sink in for a moment before acknowledging that he bets 300 days per year and has his share of leaks, particularly a predilection for spread betting, in which the amounts of your profits and losses hinge on the number of points your team wins or loses by. "It's great fun but very volatile," says Tuohy. "When it hits, you can't drink your beer fast enough because you're making so much money. But it can go very badly the other way as well. I've burned my fingers on spread betting."

The degree to which one can burn more than their fingers at Betfair—where hundreds of wagers can be placed over the course of a single sporting event—is illustrated by the saga of Andrew Petrie. Petrie had been the director of a major U.K.-based pension fund, out of which he siphoned nearly $3 million over a six-month period to cover his Betfair wagers. Petrie's goal, before getting caught, was to become a layer of bets—that is, he would bet on horses to be defeated and take action from people aiming to pick winners. After his court hearing, Petrie told the Wolverhampton Express & Star, "I ended up a big loser. The horses kept on winning and I had to pay out. It just spiraled out of control and I carried on taking the money in the hope I would win enough to pay it all back." Of course, he didn't. When the situation came to light, Betfair returned around $350,000 (in commissions) to the fund, and Petrie received a six-and-a-half-year prison sentence.

As can be gleaned from Petrie's mess, the size and scope of Betfair is stunning. On a busy Saturday, 2 million bets are processed through its system, making Betfair busier than the London Stock Exchange and the largest of 15 similar betting services in England (the company claims to have a 90 percent market share). Its floor of offices, situated in an impressive glass and steel building overlooking the River Thames, is crowded with tech specialists and multilingual customer service people. But there's nary a line maker in sight, which illustrates the beauty of this operation: its customers do the hard work of setting lines and figuring odds, while absorbing all of the risk and volatility. Though bookies complain about Betfair—insisting that it unfairly takes away business, turns bet makers into bet takers, and hurts the integrity of racing by allowing bettors to wager on horses to lose—they also flock to it. "Bookies use us to hedge their positions," says co-founder Wray. "They also use us as an indication of where the market is. What we see here in the U.K. is that when the horse-race market used to open, bookmakers would not give early prices on the races. Our market opens the day before, an early price forms, and it's a pretty accurate early price. People use that as a benchmark."

An illustration of Betfair's ability to go where the bookies won't can be seen in a goofy bet that few serious gamblers would risk their money on. As is the custom, British sports books took action on the 2000 U.S. presidential election. That was all fine and good—until there was no immediate winner. At that point, says Wray, "Nobody had an idea of who would win, and the bookmakers stopped offering a price. We turned things right back on and let the public decide."

Ironically, despite a strong presence of National Football League and Major League Baseball action on Betfair (not to mention the odd election), Americans are barred from using the service. Unlike other online sites, Betfair won't take action from stateside gamblers. "We don't allow anyone with an American credit card to bet with us," says Wray, explaining that Betfair has sites specifically aimed at gamblers in Europe, Africa, Australia and Asia. "We will not stick [a middle finger] up at other jurisdictions and tell them that we don't believe in their laws. We want to eventually work with those jurisdictions." The attitude might be viewed as admirable by antigambling advocates, though there is a way around the restriction (which doesn't stop anyone from just visiting the site at www.betfair.com): simply use a credit card from an offshore bank, maybe a lending institution in Grand Cayman, and join Betfair's 200,000 or so registered non-American customers who create the liquidity that bettors and traders crave.

But U.S. lawmakers are not the only ones who might take exception to Betfair. At home in Great Britain, a parliamentary committee recently recommended that the government should look into registration of those who lay bets above a certain threshold. Naturally, Betfair and its biggest customers have balked at this. Whether it gets put into law and proves enforceable has yet to be seen. But even Andrew Black, who hates the prospect of legislation, acknowledges, "I think [Betfair] has created a new class of [professional] gambler in the U.K. I see evidence of it in our chat rooms, which are incredibly busy."

Representative of the new class is Glen Alcoe. Unlike John Tuohy, who had always been a run-of-the-mill punter, game to bet on just about anything, craving action more than winning, young Alcoe is a supersharp advantage player. He's become even sharper with the advent of Betfair. A nerdy-looking guy with a PhD in mathematics who put himself through college by using modeling software to successfully bet on horses, Alcoe is one of the more successful traders on Betfair, and, like a savvy stock investor, he makes his money by finding opportunities that other people overlook. "There are certain predictable ways that the market is expected to move," says Alcoe, who consults with Betfair, providing a customer's perspective on ways in which the site can be enhanced. "Some horses, you know they will be popular, and you can see their prices building up. They often take a long time to be corrected, and it's really a case of knowing when these forecast prices are wrong. The other interesting thing to do is arbitrage with bookmakers and the tote board. Due to short-term fluctuations, I've had opportunities to back all the runners in the same race with no chance of losing money."

Never mind that this is as sweet as it gets for a horseplayer, it also happens to be as tricky as outsmarting a fast-moving NASDAQ. Even as Alcoe casually tells me that none of his friends are especially surprised by his success as a bet trader—thus making it sound like a piece-of-cake proposition—I keep hearing the more measured words of caution from Andrew Black: "If somebody's smart and he works hard, he will win money on Betfair. However, there are a lot of very clever people out here, and it's not easy. But why should it be? This is survival of the fittest."

Michael Kaplan is Cigar Aficionado's gambling columnist.

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