The sports betting industry has evolved significantly over the years, now incorporating advanced technologies and the rise of prediction markets that present new market-making opportunities for bookmakers. While traditional sports betting and prediction markets share some similarities in financial modeling and pricing, prediction markets function as derivative exchanges and depend on market-making for liquidity between buyers and sellers. Early prediction platforms, like Betfair in the UK, struggled primarily due to insufficient liquidity. Unlike these, in sports betting, the bookmaker serves as the counter-party to all trades, eliminating the need for complex mechanisms.
As the boundaries between finance and betting continue to blur, bookmakers face several challenges. Nevertheless, many leading betting companies have begun to engage in prediction markets in various capacities. If market-making is likened to bookmaking since both involve taking risks to profit from event outcomes, there is potential for bookmakers to excel in this emerging area, and many are poised to do just that.
During DraftKings’ Q1 earnings call, CEO Jason Robins expressed optimism, stating the company could become “one of the top two or three market-makers in the world” for sports contracts, citing their superior modeling capabilities. He added he perceives no significant competition, except possibly from one or two major sportsbook rivals. Similarly, Flutter CEO Peter Jackson noted that FanDuel is actively developing in-house market-making services.
Despite both companies experiencing stock declines of over 30% this year, attributed partly to capital expenditures related to predictions, the burgeoning potential in market-making could prove lucrative.
This week, Las Vegas hosted the 19th International Conference on Gambling and Risk Taking, bringing together gaming researchers and scholars. On Tuesday, UNLV PhD candidate Shivam Sharma presented research titled “Optimal Bookmaking with CRRA Utility: Existence, Uniqueness, and Numerical Methods.” This presentation explored effective market-making practices, using the example of Kalshi contracts on MLB games. Sharma’s 20-minute session encompassed complex financial and statistical modeling akin to formal studies at esteemed institutions, such as MIT or Wharton.
Sharma explained, “How it happens is, there’s a liquidity provider, he goes out there, posts his limit order on both sides, and then a liquidity taker comes and takes the offer. It’s this dynamic between the liquidity provider and a taker that moves the prices.” He emphasized the importance of strategically posting limit orders to ensure profits through the bid-ask spread.
The swift growth of prediction markets has turned market-making into an appealing avenue to capture pricing opportunities and inexperienced traders, resembling the stock market landscape. However, Sharma pointed out that differences in payout structures and probabilities necessitate distinct modeling for predictions compared to stocks.
“Some papers discuss automated market-makers, but there’s nothing that formulates this problem within a mathematical framework and attempts to resolve it,” he remarked.
In terms of market-making, inventory control stands out as a critical factor, influenced by price fluctuations. Sharma indicated that managing inventory is essential to mitigating risk. “As a market-maker, what you are really interested in is making sure that your inventory is within certain bounds, so that you cap your risk potential,” he stated, highlighting his focus on specific game periods rather than the entire contest.
Continuous risk management, particularly during in-game betting and live pricing updates, is familiar to bookmakers. A report from Eilers & Krejcik Gaming noted in January that major U.S. sportsbooks achieved at least 65% uptime for college football games. In this context, uptime refers to the duration where at least one betting market is active.
Among leading sportsbooks, DraftKings distinguished itself with an average uptime of 86%. The expected return on turnover, a metric known as the overround, exceeded 5% across all operators, with BetRivers leading the pack at over 8%.
Robins expressed confidence in DraftKings’ ability to translate its extensive betting experience into a new stream of market-making revenue. “In terms of profitability versus investment, the market-maker should be or is profitable already,” he said during recent analyst discussions. “That’s gonna be the one that’s sort of the least capital-intensive in terms of investment, and I think it will produce really strong results in the near term and continue to grow.”
