The Economics of Sports Gambling
What happens when tens of millions of fantasy-sports players are suddenly able to bet real money on real games? We’re about to find out. A recent Supreme Court decision has cleared the way to bring an estimated $300 billion in black-market sports betting into the light. We sort out the winners and losers.
In 2012, three friends and co-workers named Jason Robins, Paul Liberman, and Matt Kalish decided to launch a startup. The idea was simple: millions of people already loved playing online fantasy sports (themselves included). But most competitions had a really long timetable — an entire baseball season or football season, for instance. What if you could draft a new fantasy team every day? How much fun would that be — and how lucrative?
At the time, other people were already working on daily fantasy sports, most significantly, a company called FanDuel. But the three friends thought they could do it better.
“We had really been trained at companies and in areas — tech analytics and marketing — that we thought were core to really building the best mousetrap in daily fantasy sports,” says Robins, who became the company’s CEO.
Their mousetrap worked. Today, according to Robins, that company — DraftKings — represents about 60% of the fantasy-sports market, with well over 10 million registered users. They play for fun, for pride, and for money: Some big tournaments offer a jackpot of more than $1 million, DraftKings typically takes a 10% cut.
Fantasy sports are wildly popular in the United States and Canada, but the fever has spread. India has 100 million players, with cricket being the most popular sport. Here, the most popular sport is football, but you can also play fantasy baseball, basketball, hockey, soccer, cycling, tennis, golf, e-sports, and so on. Fantasy revenues in the United States alone are around $8 billion a year.
What’s more, in 2018, the big fantasy-sports companies got the gift of a lifetime, courtesy of the U.S. Supreme Court, a ruling that paves the way for legalizing straight-up sports betting throughout the United States rather than just a few select places. That’s right: Legalized sports betting is coming to America.
In 1992, the U.S. government passed a law that prohibited states from legalizing sports betting. Four states were grandfathered in — Nevada, Oregon, Delaware, and Montana — but betting on actual sporting events was explicitly illegal everywhere else. This of course did not mean that people were not betting on sports in those states.
“You might have as much as $300 billion being bet in the United States every year,” says Victor Matheson, a sports economist at College of the Holy Cross. “That’s what people estimate might be going on under the table.”
Fantasy sports, meanwhile, as with many businesses born on the internet, fell into a gray area: unregulated but also not quite illegal. As the industry grew, it drew scrutiny, including a high-profile corruption charge. In 2015, The New York Times published an exposé about a DraftKings employee who had won $350,000 on FanDuel, the big rival fantasy site, by using what was alleged to be insider information. Jason Robins disputes this account, arguing that the information couldn’t have benefited the employee. Nonetheless, DraftKings responded by, among other things, banning all its employees from playing fantasy sports.
The incident attracted the attention of state regulators, who started to crack down on fantasy-sports sites because, upon closer inspection, what they were doing looked an awful lot like gambling. In most states, an activity has to meet three criteria to be classified as gambling: participants have to pay something to enter; they must receive something of value when they win; and the activity has to be a game of chance.
Against this backdrop, the question of whether playing fantasy sports was an act of skill or chance became a very important question for fantasy-sports companies. So in 2015, FanDuel contacted Peko Hosoi, a professor of mechanical engineering at M.I.T. and the co-director of the M.I.T. Sports Lab. The company asked Hosoi if she could answer this question. Hosoi said she’d be happy to look at their data, but that she’d want to publish the results regardless of what she found.
FanDuel agreed and, armed with a couple years’ worth of FanDuel data, Hosoi and her colleagues set out to analyze the roles of skill versus luck in fantasy sports. So how do you do that?
“You have to think about skill and luck as a spectrum, and ask: Where do these activities fit on the spectrum?” explains Hosoi. “Nothing is purely luck or purely skill. Like when you drive to work, it’s mostly skill, but you also got lucky that nobody ran into you.”
Hosoi and her colleagues used a model that compared fantasy players’ win fractions during the first half of a series of competitions against their win fractions over the second half. Then they fed data from a variety of competitive activities into that model: coin-flipping and stock-market investing, but also many team sports as well as cycling. They also used data from fantasy-sports play. All these activities were then placed on a spectrum from zero to one, where zero represents a game of pure luck and one represents pure skill. Coin-flipping, as expected, sat at zero. Next, about a third of the way up the skill spectrum, was the stock market. Then came the real sports, which indicated that they were more weighted toward skill.
“The one that is the top end of the skill spectrum is bicycle racing. Which makes sense because if you’re fast, you’re fast,” Hosoi says. “Sometimes you have bad luck in a bicycle race. But for the most part, whoever is going to put out the most power is going to win. So now we come to the interesting chunk of the spectrum: Basketball rewards skill the most, hockey rewards skill the least. Because basketball has a large number of scoring opportunities in each game and a large number of games in the season. So that means that one lucky shot in basketball doesn’t matter very much, whereas one lucky shot in hockey can matter a lot. And football and baseball are somewhere in the middle.”
And what about the fantasy-sports versions of those real sports? Hosoi and her colleagues found that they sat quite close on the spectrum to the real version of their sports. Meaning that yes, some luck is involved in fantasy-sports play, varying by sport, but there’s also a lot of skill.
The skill finding was obviously good news for FanDuel and DraftKings. Hosoi submitted her analysis as a part of an affidavit to the Supreme Court of New York, one of several states where the legality of daily fantasy sports, or DFS, was being challenged. “My analysis of FanDuel data,” she wrote, “shows unmistakably that FanDuel’s DFS contests are skill-based games.” Shortly thereafter, the New York State legislature legalized daily fantasy sports. Many other states have also allowed FanDuel and DraftKings to carry on.
(In the face of regulatory scrutiny, DraftKings and FanDuel had begun collaborating on policy strategy and even considered a merger, but that was blocked by the Federal Trade Commission.)
The legality of sports gambling has varied greatly over time and place. In the United States, most forms of sports gambling had been illegal in most places until last year. The push for legalization gained momentum in New Jersey in 2011, when voters there passed a non-binding referendum in favor. Soon after, the state began issuing sports-betting licenses to casinos. But the pro-sports leagues and the NCAA sued, and won, and the sports books were shut down. What followed was a series of cleverly engineered lawsuits designed to make it to the Supreme Court. The case that finally did the trick was Murphy v. National Collegiate Athletic Association. The justices voted 6–3 to strike down the 1992 federal law against gambling.
Technically, the Supreme Court did not legalize sports betting across the country; it simply ruled that the federal government couldn’t prohibit individual states from legalizing gambling. As of today, sports betting is fully legal and operational in several states, with others having already passed legislation. But only a handful of states say they are not considering some form of legalization, which means most states will likely legalize.
Legalization is expected to benefit states’ coffers as well as companies like DraftKings. They have already launched online sports betting in New Jersey and West Virginia, with many more states to follow soon. “Even in this short time and in Jersey, it’s already become a substantial portion of our business,” Robins told us. “Way more so than the same size customer fantasy revenues coming from the Jersey market.”
In time, the staggered nature in which states are expected to legalize sports gambling will allow economists to study the larger effects of legalization, and to answer questions such as: What is the optimal level of sports-gambling taxation? How is widespread gambling going to affect sports leagues, athletes, the average bettor — and society as a whole?
For now, economists like Victor Matheson have been looking at data from other places, like the U.K. Matheson says there are some clear likely winners and losers. The sports leagues are an obvious, if indirect winner: Their games become more popular as more people wager on them. But legalization also carries risk. “As soon as you have gambling, you have the potential for corruption, and we’ve seen this historically,” Matheson says. “The first major gambling scandal in Major League Baseball happened within a year of Major League Baseball forming — that was the Louisville Grays scandal. The precursor of the NFL collapsed in 1908 in large part because of gambling scandals… If people think sports are fixed, then they don’t want to watch. And so it’s this real balancing act for the leagues.”
While U.S. sports leagues have historically been opposed to gambling, it’s a different story today. DraftKings just became an “authorized gaming partner” of Major League Baseball. In the old days, sports leagues stayed as far as they could from Las Vegas, fearful of any association with even legal sports betting. But two years ago, Vegas landed a National Hockey League team, the Golden Knights; and next year, the N.F.L.’s Oakland Raiders will make the move to Vegas. The NFL itself has a partnership with the Caesars Entertainment Corporation; the NBA has a partnership with MGM Resorts. These leagues, Matheson hypothesizes, are betting that athletes who are paid millions of dollars per year won’t have an incentive to accept small bribes.
There is, however, one league that remains adamantly opposed to legalized sports betting, and that may be a big loser in the coming years: the National Collegiate Athletic Association (NCAA). The NCAA’s website says the organization “opposes all forms of legal and illegal sports wagering, which has the potential to undermine the integrity of sports contests and jeopardizes the welfare of student athletes and the intercollegiate athletics community.” Matheson says the NCAA is particularly vulnerable to corruption for a simple reason: its athletes are unpaid.
“College athletes are generating huge amounts of money for the NCAA while not getting paid,” Matheson says. “The obvious solution is to pay the athletes what they’re worth. But we’re not going to see that anytime soon, so they’re going to maintain their integrity by policing their athletes rather than, by actually giving them a living wage.”
That is not the only potential downside of legalized sports betting. For instance: The arrival of state lotteries and casinos is associated with higher rates of crime and bankruptcy. Matheson worries that sports betting may attract people who wouldn’t otherwise be vulnerable to these effects.
“Think of all those sports fans who say, ‘You know, I would never buy a lottery ticket. That’s just luck. But I know everything about sports. I should be able to win this,’” Matheson says. “And guess what? You can’t beat the casino. These amateurs who think they’re experts don’t stand a chance, but do stand a chance of really getting sucked in. And the question is how quickly can they extricate themselves and realize that ‘Yeah, I’m actually not any good at this.’”
For now, one clear winner is DraftKings. “In a few years,” says Robins, “I think there could be a $100-billion-plus company… in this space. So, we’re going after that kind of size opportunity.”
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