Business Strategy in Crypto: The Missed Opportunity for Online Gambling

The Background

In the early 2000s, I started a securities company to raise money for hedge funds from institutional investors. My early career began in commodities, so I have a strong background in derivatives, which was quite useful. I wrote options pricing programs in the late 90s, which taught me a lot about the dynamics of exotic pricing of complex investment portfolios. So tearing apart an equity long/short portfolio was a breeze in comparison, plus this skill helped me avoid mortgage-backed securities funds (which had a long history of blowing up due to the weaknesses in the existing model pricing of defaults). Because I had these skills, I was able to differentiate myself from typical fundraisers who focused on selling only. I had a marketing perspective, so I sought to understand a) what funds were investors hot to invest in; and, b) which funds could be successful. I had the skills needed to determine both. But the hedge fund business was moving fast…very fast….as each month went by new fund managers were launching funds to take advantage of the multibillion-dollar fundraising bonanza. Starting a hedge fund and collecting 2% AUM management fees and 20% of profits was a very profitable business. But by 2004/2005, the business had changed. I had made my money by raising nearly $2B from institutional investors for three funds with several deals in the $100M range. But by 2005, it was almost impossible to be a third-party marketing person. Prime brokers were offering the service for free, and managers didn’t value or understand the importance of personal relationships by deal makers like myself. At that point, you either needed to start a hedge fund of fund or transition to hedge fund seeding. I haphazardly tried both, but I wasn’t motivated to do it correctly. Not entering seeding turned out to be a grave error; a huge strategic blunder. Seeding hedge funds became a hugely profitable business.

Why do I mention all of this? Well, today, I see a similar dynamics in crypto. The problem is so much money has been made so fast; the owners are missing the bigger picture, they are relaxed, rich, fat and happy and more importantly paralysed. They only move when they are forced to move. To many of them are secretly worried about the viability of the industry and are looking for alternatives; often cash-based businesses — but some fear a cash business might dilute value. Or, they are unrealistically overconfident in the future (no one knows how the crypto game will play out in 5–10yrs). Coinbase is a good example, it is branching out into lots of new businesses, but the synergies and strategy look questionable (even if they are getting customers and new revenue — it’s coming at the cost of lack of synergies).

What crypto exchanges need to do is define their business better and use cash for strategic acquisitions. Are they really in the digital assets or digital payments business? Are they in the financial markets business? Or maybe they don’t realise, but they are in the gambling business (which could be called online entertainment)? I have written on this subject in a previous article.

When I got into blockchain in late 2017, I was stunned by how fast the business was changing. As described, I had seen something like this in hedge funds, but this was different. The speed we were moving at a then was incredible, and again I didn’t understand what was happening. For example, the ICO market, targeting the crypto community, had died by the summer of 2018, but private sales continued. I didn’t realise until much later what “private sales” meant. Media hype had peaked in 2018, but there is always a lag between outsiders and insider’s knowledge. By the summer of 2018, crypto holders had mostly understood that new tokens where mostly frauds or fakes– so true crypto believers largely stopped buying into ICOs. But the media hype opened lots of doors to savvy marketers in Asia and elsewhere to convince uneducated/uninformed outsiders to make fast cash in crypto — they didn’t know that the ICO boom was already dead. And so, these “private sales” lasted until late 2018. But that also ended, and by 2019, the ICO market was pushed to a niche market, likely never to return to its former glory.

Where We Are Today

The exchange business in crypto has flourished. However, into 2019, volumes dropped off, so exchanges started looking for opportunities to restore revenue.

It’s not surprising that cryptocurrency exchanges are mostly mimicking financial markets business strategies. The pie for unleveraged crypto trading isn’t growing, so it’s hard/costly now to steal market share from competitors. Instead, players are pursuing either entering futures trading or trying to specialise in niche plays like IEO or STO offerings. The crypto exchanges need to consider the real risks that a) crypto markets could go into an extended winter which will lead to significant drops in profits/trading volumes in the industry, forcing consolidation, or bankruptcies, or worse, b) the entire industry could become a small niche business. So it’s not surprising that the likes of Coinbase are even trying new activities like institutional custody (think Prime brokerage). When you consider that Bitmex has 10% of all futures trading in the market (maybe more), you have to understand that there is a considerable potential appetite to try to steal business from them. But adding futures will also have its limits for expansion since it’s all based on crypto volumes anyway, which are currently consolidating. By the way, and this is an interesting point, there is some evidence that as crypto exchanges added futures, they increased overall market volumes (they grew the pie, not just taking business from Bitmex). As a gambling regulator who licensed over 100 companies, this doesn’t surprise me, because what happens when you add synergistic products is that some of your existing customers migrate to the new product (you extract new revenue from them). This is why sports betting sites like BWIN offer casino, slots, virtual sports, poker, lottery, etc. — they understand gamblers will still specialise in their favourite product. But, some 10–20% will crossover to new offerings, increasing revenue per user. And this fact brings to me to why crypto exchanges should be looking at gambling now.

From my perspective, the exchanges are missing a massive opportunity. Something they should be understanding by their successes in adding futures trading on crypto. They are mostly trying to enter crypto-only businesses, without really understanding enough about their own customers’ needs and desires.

Another great analogy here is Google vs Yahoo.

I am old enough to remember when Yahoo was the dominant search engine. Google didn’t even yet exist. But Yahoo, like Google today, wasn’t too focused on UX, so it expanded into all sorts of businesses and loaded up the search page with them. All of the search engines were doing the same thing. Then google came; they focused on the search, and they simplified the UX while tweaking the search algorithms.

Google killed everyone. But as it got rich, just like Yahoo did it expanded into synergistic services (it’s still doing that today), but it removed all of those businesses off the search page and kept search simple. Those other businesses (email., voice, news, financial information, etc..) keep customers sticky and loyal. Google nearly bankrupted Yahoo with its strategy, simply because it understood its customers’ needs better than Yahoo.

I would argue that the same thing is happening in crypto. We are in the days of Yahoo and Lycos. In a few years, there will be far fewer exchanges, and they will become large destination sites offering a variety of services ranging from payments, gaming, gambling and trading. Some of today’s businesses are going to disappear or be made irrelevant by the exchanges who aggerate user behaviours the best.

Crypto is insanely profitable but still a niche business, but it’s also a commodity business with low barriers to entry, so price competition is inevitable. What these exchanges need to understand better is: who are their customers? And, what other activities do these customers seek or are actively involved in? I find it interesting that a lot of them are now entering futures trading. But in 90% of the world, futures (they way it’s conducted in crypto) trading is mostly regulated as gambling, not as a financial product (the method used on most crypto exchanges mirrors what in gambling are called “contracts for difference”). Let’s be fair, I am crypto guy, but what is crypto, is it a commodity, equity, currency or something else? I would argue it’s at best a hybrid currency, but a worst its something undefined (some tokens could go to zero, something that probably can’t happen to any real commodity). For sure, at the very best it’s a new asset class. So, what are futures on something that itself might have no value? I would argue it’s a gambling instrument!

There is simply no doubt in my mind that there is a massive global crossover between crypto users and online gambling players. The marriage between the two is so apparent to me that it screams!

Most gambling companies are investors in FX platforms because they understand the crossover. They also invest in social gaming (another area for crypto exchanges). The primary reason that they haven’t ventured into crypto (they accept it, but don’t embrace its use widely) is that they are all regulated. Most are also dividend payers now, so they trade at low PE multiples and are anathema to invest in expensive high PE businesses that will dilute dividends. Plus, crypto also appeared on the scene two years ago when the online gambling business was going through massive consolidation. That’s also been a factor since there are now a few giants; who are all looking to get into the US market (which is finally opening up to sports betting). So, gambling companies are not too interested in getting into unregulated crypto for fears it may hurt licensing opportunities in the US and elsewhere. Even if some crypto exchanges are regulated, the fact is that crypto on a global basis is widely unregulated. Frankly, this is opening a rare structural opportunity for high PE crypto business to invest in low PE income-producing businesses (gambling sites) with tremendous synergies to their existing customer basis.

Crypto exchanges, however, do have the ability to sell equity at high multiples. Still, they are generally making investments in businesses that are low cash-generating for the most part and also focused on crypto. The real opportunity is to find a synergistic activity that can crossover existing users to (and ideally can bring new users to crypto) — similar to what they are experiencing by adding futures (FX trading in fiat/cyrpto is an obvious choice too). What is most interesting is that online gambling is a low transparency business, which from a regulatory standpoint can also benefit hugely from adopting crypto as a betting currency. Everyone in gambling understands that blockchain had the potential to do what fiat cannot do; bring transparency and fast payments to gambling — reducing the risks of lost player funds and fraud. So not only is there a crossover in players/users (something I haven’t proven, but am comfortable stating from my experience), but crypto payments have the potential to revolutionise online gambling through increased transparency of players funds and casino wallets.

Crypto exchanges with broad captive crypto audience could acquire a niche gambling site and a) migrate crypto players from the existing audience to gambling, b) likely bring regular online gambling players to crypto, and c) disrupt the gambling industry by bringing transparency and player protection that regulation can’t deliver.

The crypto exchanges will figure it out. They should all be offering real FX trading already (using crypto as a payment option), sports betting (regulated if possible), casino, bingo, lottery, poker and virtual games. It seems radical to many of these exchanges because the founders come from financial markets — but crypto isn’t corn, wheat, gold or silver — it’s crypto — a new assets class that has unknown value today. And online gambling is a globally regulated business — far more regulated than cyrpto itself. While it’s sure that there is also crossover to financial investors in the crypto sphere. It’s also true that many financial participants crossover to gambling! Would it surprise anyone if I told you that many high-frequency traders are involved in crypto and gambling market-making (sports betting) and trading? Now, not all exchanges can make this transition — but the ones who do, will, in my opinion, create global gambling powerhouses. And now is the time, before the next crypto winter comes.

The crypto industry is still evolving, and it’s still moving fast- there are considerable risks to existing exchanges — there are too many of them. Like the hedge fund industry in the early 2000s, you must adapt or die — you need to consider how you can maximise benefits for and from users. From my experience, as a gambling regulator, I can see that consolation is coming (just like it did in gambling, as both are commodity industries with low barriers to entry). Now is the time to look for strategic opportunities that offer real synergies. I urge the largest exchanges to do something bold and venture into gambling — you won’t regret it, and you may regret missing this opportunity later.

Editor’s Note: When I came up with this idea I was so excited about the concept that I just didn't think about the fact that most sports betting websites are highly regional in nature. And crypto users from some exchanges are often spread widely among different countries. Plus, even big companies change the landing pages to reflect the betting markets popular to the local IP used (some with language preferences). This does add some complexity (both technical and scalability) to the company since traders are often needed for risk management and markets offered should be created and handled efficiently. The other potential problems related to regulatory concerns such as licensing and KYC/AML self-exclusion, and age verification requirements that will be needed in gambling that don't exist (at least partially, in crypto); these factors will mean that some jurisdictions served by exchanges won't initially be able to offer gambling to some existing exchange users. These problems can be summarised as issues of scale, technology and regulation. But these challenges will also create opportunities. Moreover, as consolidation happens, and it will happen in crypto, especially in the overcrowded exchange market, scale problems will subside. Finally, the addition of gambling is certain to create an ideal use case to help fiat players cross over the gambling simply because any exchange offering cyrpto gambling will almost surely also offer fiat gambling — giving fiat players the opportunities o buy or be paid winnings in crypto. And for exchanges that don't want a fiat pathway, there is an excellent opportunity to use Tether (USDT) as a gambling token.