Editor’s Note: The following article is adapted from the same-named audiovisual presentation given by the author to Eric Waz of BettorIQ. You can watch the presentation by clicking here.
The sports betting landscape is highly regulated and equally nuanced, leading to a unique set of challenges and opportunities, particularly in light of the novel coronavirus pandemic that has impacted sports leagues worldwide.
Challenges & Opportunities
The regulatory burden of operating in the sports betting space is enormous, particularly for international stakeholders who are less capable of navigating the balkanized legislative landscape here in the U.S. Building cutting-edge technology platforms and user interfaces relies on a highly skilled workforce with deep insights into consumer psychology. However, there is a major lack of domain expertise and intellectual capital that is also attached to U.S. passports and work visas.
Even for those who can manage the regulatory and technological hurdles, the Total Addressable Market is currently constrained by a lack of education on behalf of prospective users. And, there is also the issue of actual customer adoption and user onboarding, made difficult by stringent geolocation and KYC/AML requirements.
Challenges aside, the opportunity set is massive. In the immediate term, we will see sports betting and online gaming serve as vehicles for human connection. One major question on this topic, highlighted by the success of DraftKings’ stock price, is whether U.S. operators can achieve network effects among their user bases, which some analysts claim would be required to justify a tech-company-like multiple in their valuations.
Historically, virtually every other market has evolved and matured without this being the case. Currently, if one person places a wager with DraftKings, for example, but all of their friends place wagers with FanDuel, the whole group can still enjoy that game and interact seamlessly. However, if one person posts pictures exclusively on Facebook and all of their friends post exclusively on Instagram, there is an issue.
Functionalities such as peer-to-peer wagering, competitive video gaming, and social casino play, as well as loyalty programs that resemble those of airlines and hotel chains, may serve as conduits for the breaking of this trend.
There are also a number of types of consolidation that are expected to take place in the space. Relevant here is the merging of content and functionality. Below, we see a screenshot of a trial run by NBC Sports Washington, where a betting-type proposition along with the box score are found on a single screen, right alongside the game itself.
Innovation is important to all businesses, not being afraid to fail, check out NBC Sports Washington for a fun test. Read this https://t.co/IYg5qXIudB
— Ted Leonsis (@TedLeonsis) January 9, 2019
And then, on the M&A front, it seems both the pre- and post-COVID worlds will largely see deal flow driven by access to licenses, customers, and technology.
With an estimated $150 billion having been wagered annually by U.S. bettors in illegal offshore or domestic markets prior to the repeal of PASPA, there is a ton of commercial interest in the direction that this industry takes. There are a number of compelling trends worth noting, with the caveat that they are all impacted by a different combination of challenges, some of which we discussed above.
Alternative Asset Class
One major area of interest is in sports betting as an alternative asset class. Placing a sports wager and buying a traditional security are said to be mathematically isomorphic in that both have the shared objective of maximizing risk-adjusted return.
Sports betting strategies can be proven to provide returns that are uncorrelated with any other asset class, which is a compelling prospect for portfolio managers seeking to diversify risk. For example, the following correlation matrix shows the relationship between the returns provided by major asset classes and a betting strategy that places wagers on all NFL underdogs playing against teams coming off an against-the-spread (ATS) loss.
In addition, the potential inefficiencies found in illiquid, nascent markets that often contain information asymmetries offer further allure to those attempting to generate alpha. However, the liquidity challenges and execution risk are massive. In addition, the house edge charged by books requires an even greater performance threshold for long-term profitability.
Pricing & Risk Engines
Many people don’t realize that companies like DraftKings and FanDuel aren’t even in the business of setting odds. That’s what companies such as IGT and Kambi do. Rather, B2C operators are customer acquisition and retention engines that leverage economies of scale and make use of the law of large numbers to ensure profitability over the long run.
Though the barrier to entry may be steep, the opportunity for disruption in the space of pricing and risk engines is tremendous. Scalable enterprise solutions for setting odds and managing risk rely on sophisticated predictive tools, advanced mathematics, and cutting-edge software. This amounts to a substantial barrier to entry, insulating many incumbents from innovative competition. Successful ventures would allow operators to benefit tremendously from improved profitability and an enhanced user experience. The holy grail for building a platform like this would be obtaining a revenue-sharing agreement with operators who utilize it, though these are often difficult to secure.
Sports Betting Bots
We will also see a rise in automated sports betting bots, which are built on top of sophisticated forecasting models that can algorithmically identify arbitrage opportunities and pursue them instantaneously. That said, execution risks and liquidity constraints will prove especially difficult for those who are not adequately prepared.
Blockchain technology also has its applications in the sports betting and iGaming space. Particularly within online casinos, “provably fair gaming” is the use of a distributed immutable ledger to ensure that the advertised payouts of a game properly correspond to the actual long-term frequency distribution of outcomes. If every card that is dealt in a digital blackjack hand is immutably recorded, users can verify that, over the long run, the properly proportionate mix of cards have been dealt.
Smart contracts, an invention of the Ethereum blockchain, allow for guaranteed and instantaneous payouts. Imagine you previously placed a wager on an event that will not be decided for 12 months. Now, due to COVID-19, that sportsbook seems like it may go out of business. If that’s a long-shot Super Bowl future that ends up hitting, you will not be happy if there is no solvent company around to pay you. On the other hand, if the operator had to store the amount of funds necessary to pay you in a fully funded, digital escrow account, which was set to automatically distribute the funds according to the game outcome, you would be feeling a lot more comfortable.
Blockchain also allows for the streamlining of internal accounting procedures and real-time insight into an operator’s P&L. The main challenge to widespread adoption within sports betting, aside from the regulatory burden and gap in market education, is that the mechanism as described is incredibly capital intensive.
Considering the astronomical costs of customer acquisition, it is very difficult and expensive to convince a new user to sign up and make a deposit at a sportsbook. Onboarding logistics should be the last thing that should prevent such a conversion event from occurring. Nonetheless, inability to verify a customer’s geolocation, complete KYC / AML, or accept payments are frequently barriers to adoption. The veritable gold rush for acquiring and retaining U.S. sports betting customers has provided a commercial opportunity for those who can leverage technology to mitigate these pain points.
Machine Learning is a subfield within Artificial Intelligence that is transforming virtually every industry known to man. And though sports betting is no exception, the adoption has been a bit slower. That said, there are a few key use cases to which Machine Learning is currently being applied in this industry, though it is by no means an exhaustive list:
- Oddsmaking: It has historically relied on simulation-based predictive engines, but machine learning offers more efficient alternatives that give rise to more robust in-play and micro betting markets;
- Risk management: The process of moving lines to attract a risk-minimizing proportion of wagers on either side of a market can also be optimized by the superior predictive power of machine learning;
- Recommendations and personalization: Netflix famously saves $1 billion annually by using a machine learning-powered recommendation engine to keep viewers watching, while Facebook and LinkedIn utilize similar engines to keep users scrolling. The application within sports betting would be a curated stream of promotions and bonuses as well as a more personalized user flow that presents a customer with odds and offers that they are most likely to be interested in;
- “Responsible gaming”: The industry term for the suite of mechanisms by which customers are kept from the ills of addictive tendencies. However, the term “sustainable gaming” better confers the notion that the entire sports betting and larger sports entertainment ecosystem benefits when customers are kept safe and the integrity of underlying sports leagues is preserved. Machine learning offers the potential to proactively detect deviations from sustainable gaming behavior in real time;
- Fraud: It’s particularly rampant in the gambling industry. As such, increasingly sophisticated tools need to be deployed in order to combat such efforts, as well as to fortify KYC and AML efforts.
Coming up in Part II: Product Innovation, Startup Verticals & Conclusion.
Follow Danzig on Twitter @LloydDanzig and his sports gaming advisory firm @SharpAdvisors.