The Case for Exchange Wagering

Lloyd Danzig
19 min readFeb 7, 2020


Whether placing wagers onshore or offshore, most US sports bettors have only interacted with what is known as a fixed-odds sportsbook, where the payout on a given proposition is set by the operator and fixed at the time the wager is made. Contrary to semi-popular belief, however, this is not at all the only format used for facilitating sports wagers. There are a limited number of parimutuel sports betting platforms, for example, though the format is far more common in horse racing, where track operators do not settle on payout odds until the distribution of wagers has been finalized (thereby guaranteeing a riskless profit).

There is a third form of wagering, however, that offers dramatic benefits to a number of stakeholders — exchange wagering. Exchanges have been prominent in sports betting in Europe for years. Betfair is a clear market leader, followed by Betdaq, Smarkets, and Matchbook, generally in that order. Betfair does run a horse racing exchange wagering platform for New Jersey customers, but no such functionality exists for traditional sports, and liquidity is considered to be limited. The opportunities and challenges presented by exchange wagering are a major component of the way in which the US sports betting market will evolve over the coming decade, and properly understanding why will be a valuable undertaking for any industry participant.

Terminology & Notation

As is the case in much of the betting universe, exchange wagering brings with it new terminology, notation, and mechanics. You rarely hear people say that they “placed” or “made” a wager on an exchange, because those terms fail to convey a piece of information relevant to that arena but not relevant at fixed-odds sportsbooks. Exchange wagers are generally referred to as follows:

  • To “back” a proposition is to place a bet predicting that an event will happen. This is similar to the traditional type of wager with a fixed-odds bookmaker.
  • To lay a proposition is to place a bet predicting that an event will not happen.

Consider the following market depth and available odds for a matchup between the Miami Heat and Orlando Magic, where odds have been converted to American notation for simplicity.

Let’s break this down by first walking through an example, assuming we wish to bet on Miami to win the game outright. We will first look at the odds offered for backing Miami:

The odds for backing move from most favorable on the right to least favorable on the left. This tells us that, between all of the other participants on the exchange, there is €630 worth of interest in accepting a wager on (“laying”) Miami at -125. We should take a moment to notice that this is the equivalent of those people betting Orlando at +125. This is because on an exchange, bets only exist to the extent that willing participants take the other side at the same odds. We also see that there is €326 worth of interest in laying Miami at -134 and another €144 at -136.

Let’s quickly look at at how much one would win by successfully risking €100 at each of the available Miami odds:

  • -125 — €80.00
  • -134 — €76.63
  • -136 — €73.53

In the US securities industry, Regulation NMS mandates that all trades be executed at the best possible price, the NBBO (National Best Bid and Offer). There are no current federal requirements to execute sports wagers at the best possible odds in the US, but it has long since been considered standard practice to do so in places where the format is popular. Still, there may soon come a time where such a regulatory body is needed for the US sports betting market.

Basic Mechanics

Suppose a user sought to back Miami and wager anywhere up to €630. They would do so at odds of -125. Simple enough. Any amount wagered beyond that, up to a total of €956 (€630 + €326), would be risked at -134, and so on.

Thus, a customer wishing to back Miami with a stake of €1,000 would have exposure as follows:

Back Miami Heat — Risk 1,000

Euro values of €100, €0, and €0 represent remaining interest at those odds after customer backs Miami

As is the case when trying to buy or sell a large number of shares of stock, some parts of our “order” will be executed at different prices:

We see that the blended moneyline is approximately -128. In other words, had we placed a single wager of €1000 at odds of -128, we would win the same amount that we will win with 3 separate bets at the varying odds at which backing Miami is available.

However, exchanges offer another option beyond placing traditional wagers. If backing Miami is betting them to win, then laying all of the options that are not Miami should be logically equivalent. In this particular case, the only option would be Orlando. In essence, we can take the €1000 that was going to be used to back Miami and, instead, offer it up to someone who wishes to bet on (back) Orlando, in the process called laying.

If we lay Orlando at +125, we are agreeing to pay our counterpart €125 for every €100 that they risk, which is the same thing as us winning €100 for every €125 that we risk on the proposition that Orlando loses. This is, effectively, identical to wagering that Miami will win at odds of -125.

Based on the methodology we used previously, our bets would look as follows:

Lay Orlando Magic — Risk 1,000

Euro values of €0, €0, and €73 represent remaining interest at those odds after customer lays Orlando

Again, our order will have to be executed at different prices:

Now, we see our blended moneyline has decreased to approximately -126. Instead of winning €780 if Miami wins, we can now win €792 on the same outcome without risking anything extra.

When laying a bet, we are offering to pay out a fixed amount at the agreed upon odds. So, if we lay Orlando at +200 for €500, the person or persons on the opposite side of our wager will be risking €250 to win €500.

The Value of Liquidity

You may have noticed that laying can produce more favorable payouts than backing, even when wagering on the exact same outcome.

To seasoned bettors and investors, this may seem self-evident, but for most, the reason why is not entirely intuitive. Recall that exchanges, not just for sports betting but for securities and other assets, make money by charging a commission on the funds that move across their platform. This creates an ecosystem in which:

a) the goal is to maximize the dollar-weighted volume of transactions on one’s platform

b) certain types of transactions can be seen as more valuable than others

Specifically, orders sent to exchange that add liquidity are more valuable to the operator’s core business and profit margin than orders that remove liquidity, as they allow it to better execute on its value proposition.

If we offer to accept to €1000 worth of risk on the proposition that Orlando loses, there is now a larger universe of bets that future customers can place as compared to the moment before we decided to lay our bet. On the other hand, if we back Miami, we are taking someone up on their offer to accept risk, thereby decreasing the universe of bets that future customers can place.

A Word on Market Makers

On the New York Stock Exchange, stakeholders known as Designated Market Makers (DMMs) and Supplemental Liquidity Providers (SLPs) are actually paid a fee (often referred to as a “rebate”) for increasing the amount of liquidity on the exchange. To slightly oversimplify things, DMMs typically commit to making a two-sided market, at or near the NBBO, for a given number or cross-section of securities. This means they are guaranteeing the exchange that they will always be willing to both buy and sell specific securities at a competitive price.

The NYSE is happy to do this because its success is based on other financial professionals relying on its liquidity to execute orders. A stock or bond trader wants to know that their order is going to be filled promptly and at a reasonable price, otherwise they will place the orders elsewhere.

On many cryptocurrency exchanges, you will hear people refer to makers, who provide liquidity to the order book, and takers, who remove liquidity from the order book. The commission structure charger to the former party is typically far more favorable than the latter, even if they have identical exposure to movements in the price of a given currency.

Betting exchanges also are successful only to the extent that their customers rely on having wagers matched. As such, it makes intuitive sense that those who add liquidity by laying bets will receive more favorable net payouts than those who remove liquidity by backing bets.

A market maker in $AAPL, trading at $325.65 at the time of writing, might make a $325/$326 market, meaning they are equally willing to purchase shares at $325 as they are to sell shares at $326. Similar to the way risk is managed in the sports betting industry, as long as an even number of shares are bought and sold at those prices, the DMM will have a guaranteed profit. However, if there are only buyers or only sellers, the DMM will have to change their bid and/or offer to properly match the prevailing sentiment in the market.

To illustrate this, imagine we have 3 $AAPL market-makers who buy or sell a total of 50 shares (buying at $325, selling at $326) over the course of one day. Specifically, we have:

  • One market maker (DMM #1), who purchases 25 shares and sells 25 shares, ending the day with an inventory of 0 shares
  • DMM #2, who purchases 40 shares and sells 10 shares, ending the day with an inventory of 30 shares
  • DMM #3, who purchases 10 shares and sells 40 shares, ending the day with an inventory of -30 shares (meaning they are either short 30 shares, or have 30 fewer shares than they did at the previous day’s close)

We can, certainly, calculate their profit or loss for this trading day (referred to as “realized gains and losses”):

However, this fails to take into account the fact that DMM #2 is still “long” 30 shares of $AAPL and that DMM #3 is “short” 30 shares, the potential capital gains or losses on which we refer to as “unrealized gains and losses”. This is where the potential for the next day’s price movement comes into play:

We can use two different scenarios to reinforce our point:

Scenario 1 — $AAPL share price moves to $330

In the scenario where $AAPL moves up to $330, DMM #2, who still owns 30 shares, will end up profiting, while DMM #2, who is short 30 shares, will wind up in the red.

Scenario 1 — DMMs transact shares of $AAPL at a bid/ask of $325/326; price moves to $330 the next day

Scenario 2 — $AAPL share price moves to $320

In the scenario where $AAPL moves down to $320, DMM #2, who still owns 30 shares, will end up in the red, while DMM #3, who is short 30 shares, will wind up profiting.

Scenario 2 — DMMs transact shares of $AAPL at a bid/ask of $325/326; price moves to $320 the next day

What we quickly notice is the DMM #1 has the same profit in either case, best illustrated by the difference in standard deviations among the two scenarios:

Investors and business owners typically like predictable, reliable, and stable profit streams that are not too capital intensive. DMMs #2 and #3 in our example above would provide exactly the opposite of this.

In theory, savvy sports bettors could choose to make markets on a betting exchange. Especially in cases where liquidity is limited and the gap between the odds of two opposing teams is large, there is a potential arbitrage opportunity, if and only if one can attract the proper proportions of wagers on either side of the market.

Betting Exchange Economics & The Competitive Landscape

As a refresher, fixed-odds sportsbooks are ones in which customers view odds set by the sportsbook and then have the choice to accept or reject, but not make counter offers. The odds of the customer’s wager are fixed at the time the wager is placed, and the operator makes money by incentivizing the proper proportions of wagers on either side of a market such that risk is minimized. A comprehensive overview on bookmaking economics can be found here, but the graphic below should serve as a solid foundation for the purposes of this discussion.

A betting exchange, on the other hand, functions just like a limit order book on a futures exchange, and operators make money by maximizing liquidity and taking commissions. Here, willing participants are matched in peer-to-peer fashion and so customers serve as counterparties for other customers.

Rather than the operator of an exchange building expected profitability into their odds, they simply take a guaranteed percentage of winnings, typically starting around 5%.

Betting Exchanges vs. Fixed-Odds Sportsbooks

Generally, all parties are better off having used an exchange because the operator does not need to be compensated for providing liquidity or exposing itself to information asymmetries. There also exists ample academic literature confirming that the market-clearing odds on a betting exchange with sufficient liquidity are more predictive of actual outcomes than nearly any other data source.

We assumed a 5% commission was charged on winnings on the exchange.

Above, we compare two metrics:

  • The amount of money won as a result of a successful $100 wager
  • The amount of money required to be risked in order to win $100 with a successful wager

We can see that both Alice and Bob would have won more money having risk the same amount on the exchange as compared to the fixed-odds sportsbook. Additionally, they each would have had to risk less on the exchange to win the same amount they won at the fixed-odds sportsbook.

Betting exchanges are not only attractive to bettors, but to operators as well. DraftKings, FanDuel, PointsBet, William Hill, and the like all spend incredible amounts of time, money, and effort ensuring that they are not financially over exposed to any particular sporting event outcome. Predictive analytics and modern data science techniques have enhanced these efforts, but the difficulty remains.

For example, the 2019 Super Bowl was one in which the Los Angeles Rams opened anywhere between a 1-point favorite to pick’em against the New England Patriots. Many analysts were heard discussing how a mid-season matchup between these teams, at a neutral site, would be a pick’em game, and thus the spread made sense to them.

However, what all the models failed to take into account (apparently) was that this was not mid-season and it was not a neutral site. It was 4x Super Bowl MVP Tom Brady, 3x NFL Coach of the Year Bill Belichick, and their 10 combined Super Bowl rings. The public loves perennial winners, and a flood of early money swung the spread to Patriots -1.5. Some books saw the line hit Patriots -2.5, with a few showing juice of -125 on that spread, for fear of making them favorites by a full field goal.

It was all for naught, though, as 80%+ of the cash still ended up on the Patriots, who both won and covered. The moral of the story is that managing risk is difficult and not at all a solved portion of the ecosystem.

Exchanges, on the other hand, have no such concerns. Alice and Bob, in our example, are betting against one another, and only up to the extent that both have agreed as to the maximum they will, respectively, lose. The exchange will take a small fee, typically starting at 5% and decreasing on a sliding scale based on betting volume. They don’t need to be compensated for providing liquidity or exposure to information asymmetries, but just for keeping the exchange running and paying to acquire the customers who, in turn, provide the liquidity.

We can drill down further into the advantages and disadvantages offered by an exchange compared to a traditional, fixed-odds sportsbook:

Favorable Odds — Advantage: Exchange

Sportsbooks need to be compensated for the provision of liquidity and exposure to information asymmetries, which they achieve through the vigorish (“vig”) or house edge. This is experienced by the end user in the form of less favorable odds. Exchanges, on the other hand, do not have these issues and operate in a virtually riskless environment, at least insofar as the outcome of any sporting event is concerned.

Thus, as long as there is sufficient liquidity, bettors almost always enjoy more favorable odds. Consider a 50/50 market like a standard spread bet, where there are 2 propositions available to wager on and each is equally likely to occur. At a typical sportsbook, we place bets at -110, odds at which we can expect to lose ~$45 for every $1,000 wagered. On the other hand, wagering on 50/50 markets using an exchange which charges 5% commissions on winnings results in an expected loss of just $25 for every $1,000 wagered. If we are high-volume clients and get our commission reduced to 2%, we can now expect to lose only $10 for every $1,000 wagered.

Operator Risk — Advantage: Exchange

The greatest advantage of operating an exchange is that it is absolutely riskless insofar as the outcome of any particular sporting event is concerned. Of course, there are economic and regulatory risks, but operators have significantly reduced needs for risk management and oddsmaking functionalities, thereby decreasing operating costs and stabilizing revenues.

Potential Market Variety — Advantage: Exchange

In theory, any proposition or combination of propositions whose outcome can be verified using the data provider or providers with which an exchange contracts can be converted into an actionable wager between willing participants. Concerns over correlations and arbitrage attempts are irrelevant for the operators of an exchange, who are merely facilitating the provision of liquidity and taking a fee for the service. Fixed-odds operators are limited to the pricing of markets for which they expect an evenly-distributed risk profile, or at least those that are expected to have a reasonable amount of public interest.

Reward/Bonus Programs — Advantage: Sportsbook

Fixed-odds sportsbooks, particularly those in new markets, offer incredible promotions and bonuses to customers making deposits and wagers. In New Jersey, at the time of writing, it is essentially the status quo for new customers to have a deposit of up to $500 matched by their operator of choice. Though exchanges thrive based on having a high volume of customers, their model does not support nor call for such a level of spending on customer acquisition. As such, customers must factor in the way in which promotions and bonuses affect their expected value before concluding assuredly that an exchange offers more favorable payouts.

Bet to Lose — Advantage: Exchange

One of the most compelling advantages of the exchange platform is the ability to bet on events not happening. For example, as a miserable lifelong New York Jets fan, I know that they will never, ever win another Super Bowl. Ever. As such, at the outset of each season, I would be wise to place a wager on this proposition.

We know that sportsbooks all offer futures bets on who will win the Super Bowl, but very seldom (if ever) do we see them offer odds on teams to not win the game. On a betting exchange, however, I can simply see if anyone wants to wager that the Jets will win the Super Bowl in a given year. By acting as the counterparty, I would pay out if the Jets won the Super Bowl and retain the amount risked if they did not…just as if I made an outright bet on the proposition “Jets Do Not Win Super Bowl”.

This ability not only widens the available betting options, but also an incredible resource to people trying to hedge various interests.

Bet Matching — Advantage: Sportsbook

This is possibly the single area in which fixed-odds sportsbooks offer such an advantage, in terms of user experience, when compared to exchanges, that improperly timing the introduction of the latter could cause a business to fail, on this facet alone. If you use Fidelity or eTrade or Robinhood to trade stocks, you do so because you know that when you want to buy a share of Apple (NASDAQ: AAPL), one will be available for you to buy, and then when you place a sell order, there will buy a buyer. Not only this, but you assume that there will be a person on the other side of your trade who is willing to transact that share at roughly the same price as you are. The same goes to a betting exchange.

If, every Sunday morning, you go to lay a wager on a few NFL games and there are no backers, or you go to back a wager and none are available, you will likely not continue logging on to that site. At a traditional, fixed-odds sportsbook, the operator is the counterparty who is accepting all of the wagers. Unless you are an incredibly successful/profitable bettor, or someone risking enormous amounts of money, you will never struggle to get the action you desire, plus or minus a few percentage points on the odds.

Predictive Capacity — Advantage: Exchange

Some people use betting odds as predictive tools more than as wagering mechanisms. To this end, there is very compelling academic literature confirming that the market clearing odds on a betting exchange of sufficient liquidity are highly predictive of actual outcomes over the long-term.

Max Profit (Operator) — Advantage: Sportsbook

There are some times where unbalanced exposure can be a benefit to the operators. In fact, some operators occasionally choose to leave a bit of risk unhedged or unmitigated, betting on the extraordinary rate at which the public predicts outcomes incorrectly over the long-run.

While the risk-minimizing profit is available to the operator of an exchange, the maximum possible profit will always be available to the operator of a fixed-odds sportsbook.

Challenges to Adoption

One major barrier to the uptake of exchange wagering in the US is a federal law called the Interstate Wire Act of 1961, more commonly known as “the Wire Act”. Written during days where the gaming industry was populated by very different players, it sought to make it a federal crime to pass information or funds across state lines for the purposes of facilitating a wager. To pull from the act itself¹:

“Whoever being engaged in the business of betting or wagering knowingly uses a wire communication facility for the transmission in interstate or foreign commerce of bets or wagers or information assisting in the placing of bets or wagers on any sporting event or contest, or for the transmission of a wire communication which entitles the recipient to receive money or credit as a result of bets or wagers, or for information assisting in the placing of bets or wagers, shall be fined under this title or imprisoned not more than two years, or both.”

¹ Federal Wire Act of 1961

This means that, were someone to attempt to operate a sports betting exchange in the US, bettors could only be matched with other users in the same state. For example, to pull from our Detroit Pistons-New York Knicks example from earlier, if Alice was located in New Jersey and Bob was located in Delaware, both states where mobile sports wagering is authorized, they still would not be able to be paired. This inability to pool liquidity across states is a major concern and barrier for the prospective operators of exchanges.

One solution is, of course, a repeal of the Wire Act or a reinterpretation thereof that allows for such wagers to cross state lines. In the short term, there would be numerous difficulties with such an endeavor, not the least of which is the powerful land-based casinos which have an understandable interest in ensuring that customers come on to their properties where they also purchase hotel rooms, meals, and spa treatments. In their eyes, mobile sports wagering and the ability to pool liquidity across states will disincentivize customers from traveling to such a location.

Some countries and industries have circumvented such restrictions by placing all of the servers and payment processors in one single jurisdiction, and then claiming that no information or funds governed under a particular law or piece regulation are moving in and out of said jurisdiction.

Another partial solution draws inspiration from the poker industry, where the inability to share online liquidity across state lines was seen as inhibiting growth. In other words, a player in New Jersey and a player in Delaware who both wanted to sit down to play $2-$5 No Limit Texas Hold’em would not be able to sit with one another. And, if they were the only two players in the ecosystem wishing to play at those stakes at that time, neither of them would be able to find a game.

To ameliorate this issue, three states (Nevada, Delaware, and New Jersey) formed a compact in which the pooling of liquidity is permissible. This vastly decreases the amount of time a player in one of those states has to spend looking for a game and also increases the variety of games at different stakes that are available.

A similar approach in the sports betting industry could enable the amount of liquidity needed for a viable exchange. However, the other major barrier is the lack of education on behalf of market participants. Though many in the space have an intuitive understanding of moneylines, parlays, and spreads, the overwhelming majority of Americans might as well be reading another language when looking at a betting slip or sportsbook tote board. As such, there is a massive learning curve that sits between the average user and one who not only understands the intricacies of wagering on sports, but also knows how to and desires to navigate an exchange.

Closing Thoughts

The growth of exchange wagering in the US is a perfect example of the paradoxical nature of the current market. On the one hand, it is virtually a certainty that a mature US sports betting market will prominently feature some form of peer-to-peer wagering that at least resembles the exchanges run by Betfair and their competitors. On the other, predicting the timing and nature of this transition is essentially impossible. Parimutuel betting is arguably even more confusing, but does offer some of the advantages that exchanges are known for. Ultimately, the key takeaway is that the model most bettors are familiar with is not the only one that will ultimately be available, and that alternatives will slowly but surely enter and then fundamentally change the betting landscape.



Lloyd Danzig

Managing Partner at Sharp Alpha Advisors || Chairman at ICED(AI)