The Commodity Futures Trading Commission recently issued a request for comments about whether and how it should regulate prediction markets. In earlier papers, I explained why the CFTC cannot rightly claim jurisdiction over many types of prediction markets. I recap that view in my most recent paper, but add some suggestions about how the CFTC might properly regulate some types of prediction markets. In brief, I suggest that the CFTC build exit options into any regulations it writes for prediction markets, allowing those who run such markets the same sort of freedom of choice that U.S. consumers already enjoy, thanks to internet access to overseas markets like Intrade, with regard to using prediction markets. Here’s an excerpt from the paper:

Those practical limits on the CFTC’s power should encourage it to write any new regulations so as to allow qualifying prediction markets to operate legally, and fairly freely, under U.S. law. . . . Ideally, the CFTC would offer prediction markets something like these three tiers, each divided from the next with clear boundaries.

• Designated Contract Markets. Regulations designed for designated contract markets, such as the HedgeStreet Exchange, would apply to retail prediction markets that offer trading in binary option contracts and significant hedging functions.
• Exempt Markets. Regulations for “exempt” markets, which impose only limited anti-fraud and manipulation rules, would apply to prediction markets that:
  • offer trading in binary option contracts;
  • thanks to market capitalization limits or other CFTC-defined safe harbor provisions do not primarily support significant hedging functions; and
  • offer retail trading on a for-profit basis.
• No Action Markets. A general “no action” classification, similar to the one now enjoyed by the Iowa Electronic Markets, would apply to any market that duly notifies traders of its legal status and that is either:
  • a public prediction market run by a tax-exempt organization offering trading in binary option contracts but not offering significant hedging functions;
  • a private prediction market offering trading in binary option contracts, but not significant hedging functions, only to members of a particular firm; or
  • any prediction market that offers only spot trading in conditional negotiable notes.

Notably, regulation under either of the first two regimes would definitely afford a prediction market the benefit of the CFTC’s power to preempt state laws. It remains rather less clear whether the third and lightest regulatory regime would offer the same protection, though the cover afforded by its two “no action” letters has allowed the Iowa Electronic Markets to fend off state regulators. Markets that by default qualify for the third regulatory tier described above thus might want to opt into the second tier, so as to win a guarantee against state anti-gambling laws and the like. So long as they satisfy the first two conditions for such an “exempt market” status, public prediction markets run by non-profit organizations or private prediction markets that offer trading only to members of a particular firm should have that right. Why offer this sort of domestic exit option? Because it would, like the exit option already open to U.S. residents who opt to trade on overseas prediction markets, have the salutatory effect of curbing the CFTC’s regulatory zeal.

The footnotes omitted from the above text includes this observation: “Because they fall outside the CFTC’s jurisdiction, markets offering only spot trading in conditional negotiable notes could not opt into the second regulatory tier.”

Please feel free to download the draft paper and offer me your coments.

[Crossposted at Agoraphilia, Technology Liberation Front, and Midas Oracle.]

A fantasy sport (also known as rotisserie, roto, or fairy-tale sport; or owner simulation) is a game where fantasy owners build a team that competes against other fantasy owners based on the statistics generated by individual players or teams of a professional sport. Probably the most common variant converts statistical performance into points that are compiled and totaled according to a roster selected by a manager that makes up a fantasy team. These point systems are typically simple enough to be manually calculated by a “league commissioner.” More complex variants use computer modeling of actual games based on statistical input generated by professional sports. In fantasy sports there is the ability to trade, cut, and sign players, like a real sports owner.

It’s estimated by the Fantasy Sports Trade Association that 19.4 million people age 12 and above in the U.S. and Canada play fantasy sports and 34.5 million people have ever played fantasy sports. A 2006 study showed 22 percent of U.S. adult males 18 to 49 years old, with Internet access, play fantasy sports. Fantasy Sports is estimated to have a $3-$4 Billion annual economic impact across the sports industry. Fantasy sports is also popular throughout the world with leagues for soccer (known as football outside of the United States), cricket and other non-U.S. based sports. [...]

Despite the economic instability, fantasy sports started to become a mainstream hobby. In 2002, the NFL found that average male surveyed, for example, spent 6.6 hours a week watching the NFL on TV; fantasy players surveyed said they watched 8.4 hours of NFL per week. “This is the first time we’ve been able to demonstrate specifically that fantasy play drives TV viewing,” said Chris Russo, the NFL’s senior vice president. The NFL began running promotional television ads for fantasy football featuring current players for the first time. Previously fantasy sports had largely been seen in a negative light by the major sports leagues.

Fantasy sports continued to grow with a 2003 FSTA survey showing 15 million people playing fantasy football and spending about $150 a year on average, making it a $1.5 billion industry. [...]

Unlawful Internet Gambling Enforcement Act of 2006

The Unlawful Internet Gambling Enforcement Act of 2006, which was an amendment to the larger and unrelated Safe Port Act, included “carve out” language that clarified the legality of fantasy sports. It was signed into law on October 13, 2006 by President George W. Bush. The Unlawful Internet Gambling Enforcement Act makes transactions from banks or similar institutions to online gambling sites illegal, with the notable exceptions of fantasy sports, online lotteries and horse/harness racing.

The bill specifically exempts fantasy sports games, educational games, or any online contest that “has an outcome that reflects the relative knowledge of the participants, or their skill at physical reaction or physical manipulation (but not chance), and, in the case of a fantasy or simulation sports game, has an outcome that is determined predominantly by accumulated statistical results of sporting events, including any non-participant’s individual performances in such sporting events…” [...]

Criticism

Some sports writers criticize fantasy sports, especially those involving team sports, of focusing too much on statistics. A player on a real team might be a team player and help his/her team win championships, but in fantasy sports that team play may not matter as much as having good individual statistics.

There was a bill presented before Congress in 1999 that would have prevented public fantasy sports businesses, the contention being that fantasy sports is in fact a form of sports gambling. That bill failed, and eventually a ‘carve-out’ was created for the fantasy sports business. In 2006, the United States congress passed the “Security Port Act”, which prohibits credit card transactions and other electronic transfers to online gambling operators; the bill includes an exemption for fantasy sports.

Players who enjoy competing in fantasy sports leagues often do very well with sports related prediction games by using their team statistical knowledge to predict the outcome of a sporting event. [...]

Developing… (as would say our Deep Throats).

Corporate and Operational Overview

Corporate Overview

Betfair is a registered bookmaker in the UK, where it operates an online betting exchange. Betfair also operates under licences in Australia, Austria and Malta and is seeking licences elsewhere within the European Union and further afield, notably in South Africa. Betfair welcomes regulation and is committed to paying the appropriate product fees in every market in which it operates.

Betfair’s main source of income is from bets placed on its exchange, from which – in line with other betting operators – it derives its money by paying out less in winnings than it takes in in losses. This core activity will continue to grow as Betfair gains access to new markets and more people turn to the internet as their preferred betting channel. Betfair is developing new revenue streams, such as providing price feeds from the exchange via its API (Application Programming Interface) to third parties, white label exchanges, and through the Betfair Mobile product.

Betfair Games, which operates Betfair Poker and Betfair Casino, as well as other exchange-enabled games, is hosted from Malta under a licence which was granted in May 2005. The Maltese licence enables Betfair to offer these products as well as the innovative P2P games, based on the betting exchange concept, to its customers.

Betfair has invested significantly in technology and employs over 200 engineers to produce one of the fastest and most resilient betting platforms available on the internet today. Betfair processes more than 5 million transactions a day and more than 300 bets a second. Supported by Oracle, Betfair processes 99.9 per cent of bets in less than one second. Betfair has more than 1,000,000 registered users and over 100,000 active monthly users.

Betfair employs over 1000 people in its offices in Hammersmith, west London, Stevenage, Dublin, Australia, Malta and Denmark. Since its launch in 2000, Betfair has won several prestigious awards, including in 2003 the Queen’s Award for Enterprise in the Innovation category from the Department of Trade and Industry and in 2004 Company of the Year at the Confederation of British Industry Growing Business Awards. Betfair became the first ever company to retain its title of ‘Company of the Year’ at the 2005 Growing Business Awards. In 2002 its founders Andrew Black and Edward Wray jointly won the Ernst and Young Emerging Entrepreneur of the Year award.

Operational and Product Overview

Operating Activities:

Betfair Ltd – A company incorporated and registered in England and Wales providing the sports betting exchange product.

Betfair Games Limited – A company incorporated and registered in Malta providing the Betfair Games product.

Betfair Poker Limited – A company incorporated and registered in Malta providing the Betfair Poker product.

Betfair Casino Limited – A company incorporated and registered in Malta providing the Betfair Casino product.

Betfair Australasia PTY Limited – A joint-venture company incorporated and registered in Australia operating under a licence issued by Tasmanian Gaming Commission providing the Australian Exchange.

Betfair Counterparty Services Limited – A company incorporated and registered in Malta providing the Betfair Multiples product.

TSE Development Ltd – A company incorporated and registered in England and Wales which exploits the intellectual property of The Sporting Exchange Limited (parent company of Betfair Limited and its subsidiaries).

Betfair pioneered the betting exchange concept. Based on the New York Stock Exchange, a betting exchange allows punters to bet at odds set by other punters rather than the bookmaker itself. Betfair’s bookmaking model results in odds which, according to one study, are on average more than 20 per cent better than the starting prices offered by conventional bookmakers. Bets are only accepted by the exchange if the full risk of each can be matched with a punter or set of punters with the opposite view. Any unmatched bets are voided, either by the punter or by the exchange at the start of an event. Betfair has no interest in the outcome of any event, as it makes its money from charging a small commission on net winnings.

Betfair has given punters greater control. They can now directly express a view that an event will happen or won’t happen. Betfair also offers genuine ‘in- running’ betting, including all horse races. Since prices tend to fluctuate during the course of an event, ‘in-play’ betting is a truly exciting development for punters, who are now able to “trade” their betting positions. Horse racing is the dominant product, followed by soccer. Golf, cricket and tennis are growth areas because of their international following and because they are well-suited to “in-play” betting.

Strategy

Our aim is simple: we want to be the unassailable choice of the punter by providing the best value, service and protection. We intend to achieve this through continued investment in our technology to ensure that our betting platform is the fastest and most resilient available on the internet; through staff training and through the adoption of best practice in relation to customer protection.

Betfair has a long-standing policy of not accepting US customers, funds or bets and in that regard ensures that it is able to detect and block unwanted usage. Betfair will only operate and market in countries in which it believes that it is legally able to do so.

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FAQs
Please find below some frequently asked questions about Betfair and betting exchanges.

Background Information

Q. What is Betfair?
A. Betfair is a registered bookmaker in the UK with additional licences in Australia, Austria and Malta. It operates a ‘betting exchange’ model which is a concept it pioneered.

Q. What is a Betting Exchange?
A. A betting exchange is a bookmaker that offsets all its risk through the use of sophisticated technology. This brings together two counterparties with directly opposing views and often results in better odds being available to all customers.

Q. When did it start?
A. Betfair launched in June 2000 and was the brainchild of Andrew Black, a former professional punter and derivatives pricing modeller. He partnered with Edward Wray a former JP Morgan Vice President and the company was formed. Andrew (known as ‘Bert’) still works at Betfair today, whilst Ed is non-executive Chairman.

Q. Who owns Betfair?
A. Betfair is a privately owned company with a range of shareholders.

Q. Have you won any awards?
A. Betfair is very proud to have won a number of awards. These include a Queen’s Award for Enterprise in the Innovations Category, an extremely prestigious business award in the UK. We are also the only company to have won the ‘Company of the Year’ award from the CBI twice, in 2004 and 2005.

Business Metrics

Q. How many customers do you have?
A. We have in excess of 1,000,000 registered customers with over 100,000 active in any given week.

Q. Where do your customers come from?
A. They come from over 140 different countries and on any one day over 50% of new registrations come from outside the UK where Betfair originated.

Q. What do your customers bet on?
A. Betfair offers a range of betting products. For sports betting there are over 50 different sports on the exchange covering events from 122 different countries. We regularly have football from 30 different countries and cover over 1000 horse races each week, added to this is a large range of other subjects such as reality TV and financial markets. Sports betting on betfair.com is complimented by an online poker site betfairpoker.com, an online casino with an innovative zero edge, and a set of unique Exchange Games offered by betfairgames.com.

Q. Where are you based?
A. Betfair HQ is situated in Hammersmith, London. We have a large call centre in Stevenage (about 40 miles north of London) and a Southern Hemisphere office currently being developed in Hobart, Tasmania. In addition to this we have a number of satellite offices around Europe including Malta, Denmark and Germany.

Q. How many staff do you have?
A. Currently 1000 around the world but expanding all the time.

Betfair’s Technology

Q. What technology platform do you use?
A. We use Oracle on Sun Solaris for our database servers. Our software is proprietary, custom software developed by us. Betex was launched in September 2003, it is a brand new n-tier J2EE based exchange platform and allows punters to place bets globally in 18 different languages.

Q. How good is your IT?
A. Betfair’s business is founded upon technology which has proven itself to be far ahead of the competition. We match over 5,000,000 bets a day which is 15 times as many as the London Stock Exchange (Betfair has the added burden of 24/7/365 operation and settlement is immediate). Oracle view Betfair as one of their top five most important customers in the world today which puts us alongside the likes of eBay and Google.

Q. What sort of volumes do you deal with?
A. At peak times Betfair matches over 5,000,000 transactions a day, serves over 3 billion page requests per week and 99.99% of our bets are handled sub-second. The technology required to do this is immense and requires significant investment and development time.

Tax Questions

Q. How do you make your money?
A. People betting on the exchange pay commission of between 2-5% from their net winnings on each betting market. Losing customers pay no commission. With our poker product customers pay a set fee (known as rake) in the same way as many other online poker sites.

Q. How much tax do we pay?
A. In the UK we pay tax in exactly the same way as every other bookmaker; that is a gross profits tax at 15%.

Q. Why is gross profit taxation a good system?
A. It provides a level playing field for all types of bookmaking. Historically other systems of taxation have favoured the more traditional bookmakers who do not have the technology to offset their risk as efficiently as Betfair does. In the modern world where internet access is widespread it is easy for customers to move around to many different suppliers and find value for money.

If a system of taxation exists in any jurisdiction which prevents high volume/low margin bookmakers (such as Betfair) from competing then customers will simply choose to bet through the internet with an offshore provider or worse are pushed into the unlicensed, unregulated black market in search of value.

A gross profits tax allows all types of bookmakers to compete for custom on an even footing and ensures a well regulated and safe environment for all punters.

Integrity Issues

Q. What is a Memorandum of Understanding (MoU)?
A. This is the name we give to an information sharing agreement signed by Betfair and a sport governing body. It allows us to share certain information about betting patterns and customer behaviour for that particular sport. We currently have 25 such agreements with many international sporting bodies and aim to cover every betting market we offer in the future. Betfair has taken an industry-leading stance.

Q. How do you monitor betting?
A. We have a large integrity team of specialists who monitor the betting patterns across all the betting markets offered by Betfair. They use a combination of software tools and experience. As the details of every bet are recorded any market can be investigated, current or historic.

Street address of BetFair corporate office (BetFair headquarters):

BetFair
The Waterfront, Hammersmith Embankment
Winslow Road – (Chancellors Road)
London, England
W6 9HP, United Kingdom, European Union