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How Do Betting Exchanges Work?

Betting exchanges are electronic marketplace for wagers on sporting events. The first betting exchanges were formed in the early 2000s and were made possible by the real-time capabilities of Internet technology. A betting exchange works in a very similar fashion to a traditional commodities exchange.

The format of the modern exchange marketplace evolved from the sale of state loan stocks in Italy during the Renaissance into an active trading venue as realized by the Amsterdam Stock Exchange, founded in 1602 by the Dutch East India Company. The products offered for sale, and purchased, via the exchange were shares in merchant ventures and trading companies. The sale prices varied based on demand and availability but they were recorded and validated by the official bookkeeper of the exchange.

Bookmaking in the racing world began in the late 1700s when Richard Tattersall and Harry Ogden began recording bets on horse races. Tattersall was a self-made man who accumulated enough wealth to start a horse auction business in London that was favored by nobles and wealthy families because of his honesty and the quality of the horses he procured. Tattersall set aside two rooms for wealthy patrons who enjoyed betting on horse races.

Ogden announced one day at Newmarket Heath that he would cover bets against every horse in the race. He is widely regarded as the first professional bookie or bookmaker. Much like the bookkeeper for a stock exchange, Ogden and his successors kept records of who bet against whom and they ensured that losses were collected from and wins paid to their respective gamblers. Bookmaking though eventually outlawed (outside of racing venues) in the United Kingdom spread to other countries and adapted itself to other sports.

Early English bookmakers assisted in handicapping until it became necessary to separate that task from the people who were handling the money. Nonetheless, bookies have continued to compute the odds (how much bets pay) for their customers. The bookmakers might lay off bets against each other to improve their balance of bets. A bookmaker's real interest is to collect a fee (the vig, from viggorish) or percentage of the money being wagered. The rest of the money simply flows between the bettors (aka punters). The less the bookie has to dig into his own pockets to cover bets, the simpler his life is.

The difference between a bookmaker and someone who merely offers bets against other gamblers is that the bookmaker is not trying to bet on any specific outcome of the sporting event. A wealthy gambler may offer 10-to-1 odds to everyone else in the room on the outcome of an exciting game but he's just gambling. A bookie may offer 10-to-1 odds if he can balance that bet against other wagers so that after he pays off the winners he has his fee left.

A betting exchange essentially removes the bookmaker from the process and gives gamblers a way to offer odds on all outcomes. In other words, if a gambler makes full use of an exchange he becomes his own bookie but outsources the record keeping to the exchange. This is very much like an investor buying and selling his own commodities or securities directly through an exchange rather than going through a broker. A bookie is therefore acting like an investing broker in facilitating transactions between opposing bettors, although in practice betting brokers are agents who represent bettors to multiple bookies through single accounts.

Betting Terminology Used by Bookies and Exchanges

Exchanges use the same terms as bookmakers to describe the bets that members place. Here is a selection of phrases and terms that are common to both bookmakers and exchanges.

Arbitrage – Bettors who attempt to cover all possible bets on a sporting event are called arbitrageurs.

Back – The bettor "backs" the team, animal, or athlete he thinks will win the event by placing a wager on that outcome. To "back the winning team" means you bet on the team and therefore won your bet, although the expression has now evolved into the more general meaning of "expressing support for the team that wins the event". The "back" is often called the "buy". Backers say "it WILL happen".

Handicap – An adjustment to the odds offered by a bookmaker or exchange to even out a lopsided event’s outcome for the bettors. Handicapping is a predictive measure, especially in horse racing where different handicappers may offer different predictions on which horses will most likely win. You can also handicap sports like college football.

In-play betting – These are bets made while a sporting event is in progress. These types of bets are also called in-running bets. This is also called live betting.

Lay or Lay betting – The bookmaker who takes your bet is laying odds or laying a bet against you. In other words, he is betting that the event will have a different (often opposite) outcome from whatever you bet on. The "lay" is often called the "sell". Layers say "it WON'T happen."

Lay off – The bookmaker may find that he has covered too many bets on one side of an event, so he turns to other bookmakers to "lay off" some of his action, making similar bets to cover his customers' wagers. On a betting exchange you can both back and lay on the sporting event, so laying off is not really an option on an exchange.

Multiples – Bookmakers may allow bettors to bundle several wagers together, offering much higher odds. Since the bettor's prediction must be right for all events the multiple bet has a higher reward for less risk.

Net winnings – When a gambler makes more than one bet on a single sporting event, his net winnings are whatever remains after his losses are deducted from his total winnings.

Odds – In all forms of gambling the odds represent how much you will win and not the chances or probabilities of the outcome of a given event upon which wagers are made. In sports betting odds indicate which competitors are favored by the betting masses, not which are most likely to win. In the movie "Let It Ride", when Richard Dreyfuss' character Trotter makes a huge bet on a single horse in the racetrack counting room, the odds on the horse drop from 40-to-1 to 8-to-1 because his wager changes how much money would be distributed to winning bettors regardless of which horse wins the race.

Place – In any competition where multiple winners may be recognized, such as 1st place, 2nd place, and 3rd place, the place is the relative position among the winners. In dog and horse racing place is the second-tier winner (as in "bet on a horse to win, place, or show").

Stake – The amount of your wager.

Traders – Bettors who arbitrage in their betting on events with no chance of making a profit may attempt to lay off some of those bets when the odds change thus giving themselves a chance to make a profit. In-play trading is riskier than pre-event trading. Traders favor exchanges over bookies because the exchanges only deduct fees from net winnings.

True Odds – This is called an "efficient market" because all bets cancel each other out. No one is taking a commission or making a profit as a third-party in the market. You will never get true odds with a bookmaker because they support themselves by deducting fees from the wagers. Hence, bookmakers calculate the odds to leave a little bit extra for themselves when all the bets are settled. However, betting exchanges are considered efficient markets because they only deduct fees from net winnings.

The Betfair Betting Exchange Model

Although there are several betting exchanges, Betfair is considered to be the largest and most active betting exchange in the world. Andrew Black realized that back and lay bets could be matched up together much like buy and sell orders on stock exchanges. Together with Edward Wray he launched Betfair in early 2000.

To use Betfair the bettors must set up individual accounts and deposit funds into the accounts. The bettors then use Betfair's system to search for events where other members of the exchange are placing wagers.

Betfair allows members to place back or lay bets. The bettors decide what odds they are willing to give each other. Hence, there are potentially no limits to the odds you can get in an exchange because each bettor decides what he is willing to offer individually.

All outstanding or unsettled bets are deemed exposure and this is money that you have deposited into Betfair's system which is committed. You cannot bet exposed money again or withdraw it. Betfair sets an exposure limit to prevent members from betting an unreasonable amount of money within a specified period of time. Members can ask Betfair to raise their limits.

The customer dashboard provides a simple Account Statement showing deposits, withdrawals, losses, winnings, and commissions paid to Betfair. Betfair's commissions are based on a point system. All the markets (see below) have a Market Base Rate (MBR) for calculating commissions. Most MBRs are 5%. All Betfair customers (members) have an assigned Discount Rate. The Discount Rate increases as you use the system and earn Betfair Points. The commission a member pays on any win is (MBR less DR) times profit (net winnings for that market).

Member funds, while managed through a single account, are dispersed to wallets for each of the different types of gambling, as well as for UK and Australian markets. An important feature of the account management system is that members can set limits on their deposits and losses. These limits work similarly to stop-loss limits in stock exchanges.

The system tracks thousands of "markets" where bets can be placed. The system provides lists of interests for members to choose from and provides clear rules for the bets that can be made. In other words, the exchange decides which types of bets can be made. Members can suggest new types of bets to the exchange but they may not be added to the list of available options.

Although most of the betting offered on Betfair covers sporting events, the exchange also facilitates wagers made on reality TV shows, corporate financial reporting, politics, and special or "one off" events.

Markets are also divided into categories such as Place Markets (which allow for multiple outcomes) and Handicap Markets. Betfair's handicapping may include Asian Handicapping, where rational number handicaps (e.g., -2.5) are used to reduce the chances of a draw score in a soccer (football) match and whole number handicaps are used to allow draws (voiding all bets). Betfair may sometimes assign two handicaps to a team, thus dividing all wagers between the two handicaps.

Betfair members can also buy and sell Multiples, Ranges, and Line bets. The system also offers In-play betting on many events, but betting will be suspended for penalties, injuries, and other disruptions to the events.

The system sets default odds for members. Backers decide how much they are willing to stake on the current odds. Layers decide how much of the backer's stake they are willing to accept at the given odds. Backers can request better odds and the system will determine if any other members are willing to lay those odds. Conversely, members can offer decreased odds and the system will determine if any other members are willing to stake bets at those lower odds.

When the system matches bets they may be placed against one or more other members depending on the amount staked or layed and the odds in play. Unmatched bets result in no wins or losses.

All bets have a Starting Price set by Betfair. Members can set limits when they make their bets. Backers can specify a minimum price and stake for the bet; layers can specify a maximum price and liability (how much they are willing to lose) for the bet.

What Differences Will You Find Between Betting Exchanges?

The Betfair model set the standard for the industry. Because it is based on how stock exchanges work, Betfair had an advantage over other market building innovators in that it could closely follow many of the practices of stock exchange markets. To compete with Betfair other exchanges have to offer similar service, facilitating the buying and selling of wagers in a vast field of sporting and non-sporting events that people are interested in wagering on.

Hence, the differences between any two betting exchanges will boil down to main points such as:

• Member perks like bonuses
• Commissions and other fees
• Software interface
• Calculating base odds
• Selection of markets
• Service stability and availability

Individual gambler preferences may decide the issues. One interface may work better for you than the other. The absence of specific markets may decide the issue.