Our analysts Michael Cyprys and Stephen Grambling discuss
prediction markets’ rising popularity and how they could disrupt
the U.S. sports betting industry.
----- Transcript -----
Michael Cyprys: Welcome to Thoughts on the
Market. I'm Mike Cyprys, Morgan Stanley's head of U.S. Brokers,
Asset Managers, and Exchanges Research.
Stephen Grambling: And I'm Stephen
Grambling, head of U.S. Gaming, Lodging, and Leisure.
Michael Cyprys: Today, we'll talk about
sports betting and how prediction markets can disrupt it.
It's Wednesday, March 19th at 10 am in New York.
Sports betting used to be against the law in most of America,
outside of Nevada. That changed in 2018, when the U.S. Supreme
Court declared a federal ban on sports betting to be
unconstitutional. As a result, many American states legalized
sports betting. Over the last seven years, it's become even more
popular and profitable. The American sports betting industry
posted a record [$]13.7 billion of revenues last year. That's up
from 2023's record of [$]11 billion, according to the American
Gaming Association.
Now, prediction markets are set to potentially disrupt this
industry.
Stephen, to set the stage, how is the U.S. sports betting
industry currently organized and regulated?
Stephen Grambling: Well, as you mentioned,
Mike, with the overturning of the Professional and Amateur Sports
Protection Act in 2018, legalization of sports betting turned to
the states. The path to legislation varies by state with
different constituents to consider – beyond even the local
government. You know, Senate and Congress, but also tribal
casinos, commercial casinos, sports teams, leagues, etc.
We now have 38 states plus D.C. and Puerto Rico offering legal
sports betting in some format, collecting billions of dollars in
taxes in aggregate. At this point, the big states that are
remaining are really only Texas, Florida, Georgia, and
California. Each state forms its own framework across taxes, what
sports can or can't bet on, and regulations around advertising.
This means a separate commission for each state regulates the
industry, in conjunction with state lawmakers,
Michael Cyprys: I see. And what exactly are
betting exchanges and how do they fit within the U.S. sports
betting market?
Stephen Grambling: Betting exchanges have
existed for a long time in markets around the world. These are
really exchanges – and are platforms – where individuals can bet
directly against each other on an event outcome, rather than
against a bookmaker. These exchanges match opposing bets and then
take a commission on the winnings and typically offer better odds
by eliminating traditional bookmaker margins.
That said, the all in commission can range at two to five per
cent. Whereas the spread on a traditional singles bet is about
five to six per cent. So, it's relatively small. This is also
known as the, the vigorish or the vig, or what the book gets to
keep. Due to the need to be perfectly balanced as an exchange,
these platforms, which operate in various markets, as I said
around the world, are generally more akin to premarket, single
bets. So single bet, or sometimes people call them straight bets,
are really just betting on the outcome of a match or the
over-under. They don't typically impact things like multi leg
bets, also known as parlays, since there's less of a consistent
betting pool.
Because the type of bets are more limited than what a sports book
offers, these exchanges somewhat plateaued in popularity in
markets like the UK. For frame of reference, we estimate these
singles bets are about $900 million in markets where it's legal
for sports betting, and roughly another $800 million in states
without legislation.
Again, this is really just the market for people who only bet on
that type of bet; that don't do both singles bets and parlays, or
parlays alone.
Mike, maybe turning it back to you, sports betting is a type of
prediction market. But from where you sit, how would you define
prediction markets more broadly, and can you give some examples?
Michael Cyprys: Sure. So prediction markets
are a type of marketplace where event contracts trade. Sometimes
they're called forecast markets or even information markets. A
core feature here is trading an outcome at an event, such as the
November election, economic indicators, or even corporate events.
But unlike futures contracts, event contracts have a defined risk
and defined reward.
Generally, they're structured as binary options, which can be
easily understood. For instance, a contract could pay a dollar if
the consumer price index, or CPI, exceeds say, 3 per cent in
March. If an investor buys that contract for 75 cents, they could
generate a 25 percent potential return if CPI comes in over 3 per
cent and they collect a dollar on that contract.
Now, the counterparty on the other side of that trade is the
investor who sold that contract, collected the 75 cents, and they
would stand to lose 25 cents potentially – if they held on to
that contract, paid out the full dollar in the event that CPI
came in hot.
What's interesting is the price of that contract becomes the best
forecast of that event happening, and so this can provide a lot
of information value.
Stephen Grambling: So, it sounds like you
could bet on just about anything, so are these prediction markets
legal?
Michael Cyprys: Not only are they legal,
they've been around for some time – though perhaps more esoteric
in nature, in terms of where we have seen contracts and types of
events traded on marketplaces. They've been geared more towards
end users and farmers. For example, event contracts on the
weather have been listed on a Chicago derivative exchange for
over 25 years.
What's new and interesting is that we're seeing new exchange
upstarts enter the space. They're innovating, they're broadening
access to retail investors, and they're benefiting from the
confluence of a number of different trends around technology
improvements – with mobile trading in recent years, the speed and
access to information, the ease of account opening, broadly
retail investors coming into the marketplace, and the pure
simplicity and intuitive nature of event contracts.
The 2024 election sparked people's interest in event contracts.
And that's persisting post election. In the coming months, we do
expect a large retail brokerage platform in the U.S. to really
help potentially mainstream event contracts.
Coming back to your legality point and question. One area of open
debate, though, is around the legality of sports event contracts,
where we expect regulators to provide some clarity around that in
the months ahead.
Stephen Grambling: Interesting, so some
have also argued that the prediction markets are not just the
future of trading, but for information in general. Do you think
prediction markets can be a disruptive force in finance then?
Michael Cyprys: Over time, potentially,
yes. I do think that's going to require participation from both
retail as well as institutional investors that can help fuel
robust and liquid marketplace. The sheer simplicity is helpful in
terms of driving retail adoption; but for institutional investors
and corporates, they could look to prediction markets as a
valuable hedging tool, with insurance-like properties – not to
mention the information value that can be derived.
Stephen, given our discussion of prediction markets and their
relevance for sports betting, how are you framing the potential
for risk and opportunity for the sports betting industry from the
application of prediction market models?
Stephen Grambling: There's a bit of a put
and take wherein existing sports betting markets, that's where
it's legal, the industry may face new competition. So, the
incumbents will face new competition from these prediction
markets being opened up. On the other hand, a new regulatory
framework could also open up new states; so the states that I
referenced before that are still out there that haven't been
legalized, all of a sudden become fair game.
Given the size of these new states, as I mentioned, folks like
California, Texas, Florida; these are enormous economies, and
they're roughly equal to the size of the existing markets. So,
the potential upside opportunity, we think, actually outweighs
the competitive risks. And we quantify this as being potentially
in the hundreds of millions of dollars, an incremental EBITDA to
some of the incumbents that operate in the space.
Michael Cyprys: That's fascinating,
Stephen. Thanks for taking the time to talk.
Stephen Grambling: Great speaking with you,
Mike.
Michael Cyprys: And thanks for listening.
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