I didn’t know about the difference between sportsbooks and exchanges, reminds me of 1P vs 3P in e-commerce
With that analogy, I’d predict that (regulations permitting) exchanges eventually win out vs sportsbooks. Exchanges have a lot of advantages:
- Capital efficiency: a sportsbook needs to reserve capital to pay out bets, so it needs to invest more capital to grow. An exchange uses 3rd-party capital, so it doesn’t have this constraint
- Breadth: a sportsbook is constrained by its capacity to create and underwrite bets, an exchange can use its broad network of bettors to create more (and more creative) bets. I’d argue you’re already seeing this, with prediction markets offering bets on the color of sex toys thrown onto a basketball court
- Pricing: an exchange is willing to accept a lower vig than a sportsbook, because it’s taking no risk (it makes money no matter the outcome). This translates to better odds for bettors
- TAM: the core flaw of sportsbooks noted in this post (that they ban sharps) doesn’t exist in exchanges. Because the exchange makes money in every outcome, it has no incentive to ban sharps. This creates a bigger, more liquid marketplace
This mirrors the 1P -> 3P shift in e-commerce, all big e-commerce marketplaces today (Amazon, DoorDash, Uber, Airbnb, etc) are majority if not all 3P.
My sense is exchanges don’t exist in the US because of state regulations, but prediction markets (which are exchanges) seem to have found a loophole. I’d argue prediction markets pose a significant threat to the online sportsbooks unless Draftkings / Fanduel start shifting to an exchange model themselves
You're spot on, in theory. Exchanges should be far more scalable, have better aggregated liquidity, offer better prices, and not ban sharps.
But in practice, exchanges have been difficult to run (till date). First, costs are massive just like for sportsbooks, especially state taxes and market access fees paid to existing state-licensed operators. Second, every state has a different regulatory regime so you can't easily aggregate liquidity across all states. Third, to make up for large costs, exchanges would have to offer custom, multi-leg parlays like sportsbooks do. But since there are thousands of different types of custom bets, these orders become way harder to fulfil in the exchange model. For tens of thousands of custom bets, how do you ensure that there's a buyer at a price that I want when I want it? So, you've to limit custom parlays, which is what the average sports bettor wants.
There are now prediction markets like Kalshi and Polymarket and new exchanges like Novig and Pred working to improve on the existing sportsbook model. I'm confident that a better model than traditional sportsbooks would emerge because customers would demand it. But these will have legal challenges since states will want to regulate prediction markets like sportsbooks - seven states have already issued cease and dessist letters to Kalshi. So the new model might require a new regulatory regime, probably under the federal government.
The exchange model is something I'm going to write about so thanks for the prompt!
I didn’t know about the difference between sportsbooks and exchanges, reminds me of 1P vs 3P in e-commerce
With that analogy, I’d predict that (regulations permitting) exchanges eventually win out vs sportsbooks. Exchanges have a lot of advantages:
- Capital efficiency: a sportsbook needs to reserve capital to pay out bets, so it needs to invest more capital to grow. An exchange uses 3rd-party capital, so it doesn’t have this constraint
- Breadth: a sportsbook is constrained by its capacity to create and underwrite bets, an exchange can use its broad network of bettors to create more (and more creative) bets. I’d argue you’re already seeing this, with prediction markets offering bets on the color of sex toys thrown onto a basketball court
- Pricing: an exchange is willing to accept a lower vig than a sportsbook, because it’s taking no risk (it makes money no matter the outcome). This translates to better odds for bettors
- TAM: the core flaw of sportsbooks noted in this post (that they ban sharps) doesn’t exist in exchanges. Because the exchange makes money in every outcome, it has no incentive to ban sharps. This creates a bigger, more liquid marketplace
This mirrors the 1P -> 3P shift in e-commerce, all big e-commerce marketplaces today (Amazon, DoorDash, Uber, Airbnb, etc) are majority if not all 3P.
My sense is exchanges don’t exist in the US because of state regulations, but prediction markets (which are exchanges) seem to have found a loophole. I’d argue prediction markets pose a significant threat to the online sportsbooks unless Draftkings / Fanduel start shifting to an exchange model themselves
You're spot on, in theory. Exchanges should be far more scalable, have better aggregated liquidity, offer better prices, and not ban sharps.
But in practice, exchanges have been difficult to run (till date). First, costs are massive just like for sportsbooks, especially state taxes and market access fees paid to existing state-licensed operators. Second, every state has a different regulatory regime so you can't easily aggregate liquidity across all states. Third, to make up for large costs, exchanges would have to offer custom, multi-leg parlays like sportsbooks do. But since there are thousands of different types of custom bets, these orders become way harder to fulfil in the exchange model. For tens of thousands of custom bets, how do you ensure that there's a buyer at a price that I want when I want it? So, you've to limit custom parlays, which is what the average sports bettor wants.
There are now prediction markets like Kalshi and Polymarket and new exchanges like Novig and Pred working to improve on the existing sportsbook model. I'm confident that a better model than traditional sportsbooks would emerge because customers would demand it. But these will have legal challenges since states will want to regulate prediction markets like sportsbooks - seven states have already issued cease and dessist letters to Kalshi. So the new model might require a new regulatory regime, probably under the federal government.
The exchange model is something I'm going to write about so thanks for the prompt!
Were you a sports better before starting this serious? Have you done any experimental market research?
I’d love to become very good, get banned, and document that journey 😅