Black or white: Can regulated sports betting beat the black market?

Getting PASPA overturned was a landmark victory for regulated sprots betting, but was also simply the first of many hurdles to be cleared. The next step is getting Americans to use the regulated product. Although firmly entrenched in the US, concrete data on the actual size of the black market is hard to come by and estimates vary wildly. The AGA claims that Americans gamble $150bn illegally on sports every year, while NBA Commissioner Adam Silver has suggested it is a $400bn industry. If that latter figure is accurate it suggests an average of $1,600 is gambled illegally on sports each year by every US adult, which is highly questionable. Meanwhile, the AGA believes that 97% of the estimated $10bn wagered on the 2018 NCAA’s March Madness and the $4.76bn gambled on Super Bowl LII were placed with corner bookies, criminal enterprises and “shady offshore operators.” Either way, the black market continues to be a thriving and colossal industry.

Speaking to EGR North America on the condition of anonymity, the director of trading for a large US-facing sportsbook operating out of Costa Rica insists the industry will carry on as normal with PASPA repealed. “The thought that people will abandon offshore books is just laughable to me. I don’t think they [legal sportsbooks] can compete. The playing field will be opened up but, if anything, it opens it up more for offshore books.” In terms of the scale of the offshore market, operating primarily from bases in the Caribbean and Central America, he says there are around 10 “extremely popular” post-up sportsbooks (players must deposit funds before betting) that “hold a good chunk of the market.” A few of the most well-known sites include Bookmaker.eu, Bovada.lv, BetOnline.ag and 5Dimes.eu. Beneath the top tier are 50 to 100 smaller post-up operators with anything between 50 and 200 clients on their books, the trader tells us.

Besides this, there are the pay-per-head (PPH) sites which charge US-based bookmakers a fee per client. The clients are given credit to bet online or via an app and while wins/losses are tracked, the sites don’t actually process any monetary transactions. These bookies tend to operate within a 50-mile radius of where they live because they have to settle up in cash. PPH, which exploded six or seven years ago when it became harder to send money to offshore betting sites, accounts for 35% of all illegal US sports wagers, according to Eilers & Krejcik Gaming. “If you’re talking about a street bookie,” our source says, “there is nothing that compares to the size of an offshore book. But if you are talking about all of the individual street bookies that work with one specific pay-per-head site, then they definitely compete on the low end with 1,000 to 5,000 clients and 10 to 15 [thousand clients] during football season. So, it’s fairly big. I think the amount of people that switched over to pay-per-head is a lot bigger than people realise.”

Weighing up the options

Ardent and determined sports bettors have been using the black market for decades, while the offshore sites have been around for more than 20 years. It’s a huge head start on any post-PASPA regulated market. If these gamblers have been using a reliable and trustworthy bookmaker, then you have to question why they would switch to legal channels. Street bookies offer a discreet and convenient service, while both them and PPH businesses extend credit to bettors – something legal operators would never do.  Some offshore sites also accept cryptocurrencies and offer a mammoth menu of sports betting markets, including live betting. In order for the legal market to compete, online sports betting legislation will need to be included in legislation, or at the very least in-person account registration for mobile sports wagering like in Nevada (60% of bets with William Hill are via handheld devices).

On balance, Chalkline Sports CEO and co-founder Daniel Kustelski thinks those using illegal channels, particularly offshore sites, will make the switch. “In terms of movement from illegal to legal, I do feel that other than highly price-sensitive customers, most will move as and when their local state delivers legal options that reduce friction, improve customer satisfaction and convenience. Indeed, even for the sharpest of players it’s a point rarely made that they have their hard-earned profit margins chipped away through offshore currency conversions. Those players are smart enough to calculate that the ‘total cost of ownership’ may be lower onshore than off, even if the prices are less competitive onshore.” Then, of course, there are the hordes of casual and would-be sports bettors, particularly Millennials, as well as those who will cross over from DFS or play both, for sportsbooks to target. This seems set to be a huge segment of the market.

Offshore book BetOnline

“There are millions of sports bettors on the sidelines that will emerge with legislation, particularly as the market matures and we see the product promoted in a sophisticated manner,” says Benjie Cherniak, MD of US sports data provider Don Best Sports. “As more and more states open up, sports betting will grow in stature and become culturally accepted, similar to what we currently see in the UK. The technology and product offerings will improve as more companies enter the space with innovative products. All of this will lead to a new generation of bettors, both brick-and-mortar within casino properties as well as online, which likely caters to a younger demographic.”

A cut of the action

By its very nature, sports betting is a product with thin – sometimes razor-thin ­– margins. Since 1984, the average hold of a Nevada sportsbook is just 5.5% (they typically keep $5.50 for every $100 bet). In 2017, $4.8bn was wagered on sports in the Silver State, with the 190-odd sportsbooks winning a combined total of $248.7m (5.1% of handle) – more than any previous year. Sports wagering is taxed at 6.75% in Nevada, yet sportsbooks operating in other states once sports betting arrives are set to face considerably higher rates. In Pennsylvania, for example, it will be taxed at an eye-watering 36% – five times that of Nevada – which will make it a non-starter for some operators. While certain other states have proposed more reasonable rates in the 10-12% range, these taxes, along with license fees ($10m for a sports betting license in Pennsylvania) and other compliance costs required to operate legally, are outlays the black market is able to avoid paying.

Then there is the controversial ‘integrity fee’ that legal sportsbooks could have to pay the professional leagues simply for the privilege of accepting bets on their sports. The NBA and MLB are demanding 1% of handle, yet the AGA argues that this is effectively a 20-29% tax on GGR. If this fee was applied to Nevada it would have meant sportsbooks had to pass $48m to the leagues in 2017. “[It’s] bullshit” is the blunt response from Dennis Drazin, president and CEO of Darby Entertainment LLC, operator of Monmouth Park, which plans to accept the first legal sports wager in New Jersey should the state prevail. “The leagues have been fighting us for six years. Early on, if they had wanted to sit down and discuss a revenue share then we would have been all in to try to work that out, but they cost us $9m in legal fees and have tried to stop us at every turn.

“Now coming forward and asking for an integrity fee – I’ve heard words ranging from laughable to incredulous and unreasonable.” He adds: “If you say to someone you want a 1% integrity fee it doesn’t sound like a lot, but they don’t understand that it is 20%. That is something that we are going to fight strongly here.” After some negotiations the controversial fee may well be haggled down to 0.25% of handle or a percentage of GGR.

However, 0.25% of handle would still equate to 5% of GGR being handed over to the leagues. In other words, $12m of Nevada’s handle for 2017. “I’m opposed to any fee,” Drazin confirms categorically. “Zero as far as I’m concerned.”

Indeed, Kustelski believes the fee would help preserve the offshore market: “The integrity tax won’t drive massive volumes of new customers offshore, but it could help perpetuate the active offshore market – a situation itself not ideal for sporting integrity.” He also says: “It is clear that absorbing the integrity tax will be difficult, particularly when you reflect that specific sports like baseball and in play typically trade to lower margins. When you consider the costs to deliver a modern, omni-channel sportsbook, there is not enough ‘bottom line’ for the fee to be absorbed fully by profit. I, therefore, would expect product pricing will be impacted as compensation.”

Behind the 8-ball

With the aforementioned costs, sportsbooks have said they will be forced to offer uncompetitive odds which will drive people to the black market. Indeed, if the newly regulated sports betting business can’t compete on odds, then price-sensitive sharps and inveterate sports bettors are likely to stick with the guy in their local bar or the offshore options. If a 1% integrity fee is applied, which the anonymous offshore trader describes as “lunacy,” he says it will means the odds offered by legal sportsbooks are going to be “just terrible.” He continues: “All they will be doing is introducing people to gambling for offshore books and for all of us to come in and say, ‘we’ll give you 1.91 instead of 1.8 and we’ll take care of you. If we have losing players, we take care of them – the government can’t do that,” he says, referring to state-run sports betting.

Furthermore, he suggests state-run sportsbooks won’t be able to match the high limits of offshore operators. “The government isn’t going to take a $2,000 bet; the most you’ll get down is $100.” Commercial onshore sportsbooks will accept decent-sized bets, yet if they can’t get close to matching the lines of the high-volume, low-margin offshore firms due to overheads then they are going to struggle to appeal to the high-staking bettors. “It becomes challenging to sell apples for a dollar when the grocery store across the street sells apples for 50 cents,” Cherniak remarks. “Put the two together [tax and integrity fee burdens] and we begin to see obstacles that could make it more difficult to compete with the illegal operators.”

It has been estimated that the black market would account for 20% of a fully licensed and regulated industry in the US. So with states having a vested interest in ensuring regulated betting flourishes and protecting tax revenue and jobs, the expectation is the authorities will be more proactive when it comes to enforcement and quelling the illegal options. Drazin, who believes $10bn is bet illegally on sports in New Jersey every year, says: “I’m told by reputable sources in the state that there are about 110 illegal and offshore sites that are in the Jersey market now and that we need to shut down or figure out a way to shut them down. I know the regulators are trying to figure it out but it’s a challenge. Let’s say you were going after these offshore sites that don’t do business here except for the illegal business, are you are going to sue them where? Here, and then try to chase them?”

One solution could be to prosecute the bettors, although Drazin says: “Most people think it is the companies doing this illegally that we want to go after and not necessarily the bettor. So, there are conflicts on the decision-making process on how we address it.” If states blacklisted offshore sites to prevent their citizens from gaining access it would probably be a ‘whack-a-mole’ scenario as there are hundreds of options to choose from, as well as the PPH operators and street bookies. They largely operate with impunity. In fact, the shadowy channels are so well established nowadays that illegal and legal markets will simply coexist. Regulated sportsbooks will have to find a way to compete and be a compelling and convenient option for sports fans. Cherniak says: “The best way to eradicate the illegal market is by creating a superior customer experience which includes strong technology, a tailored product offering, and the flexibility to adjust alongside what is certain to be a rapidly evolving market.” This is easier said than done, though.

Market forces

No one can say for sure how large the US market will become as it depends on how many states pass legislation. Last year, Eilers & Krejcik Gaming forecasted that up to 32 states could offer legal sports wagering within five years, creating an industry generating $6bn in GGR a year. If all 50 states joined in, the market would generate $15.8bn ($245bn in handle). Right now, the key stakeholders have dollar signs in their eyes. But that enthusiasm needs to be tempered as widespread, state-by-state sports betting won’t happen overnight; it’s going to be a much longer process than many people think with numerous challenges in the road ahead.

“They have an uphill battle, not even getting into where are they going to find the talent to run these companies,” our source says. “They are 20 years behind.” He also suggests state-run betting will be constrained by bureaucracy. “If we want to dump $100,000 into marketing, we just do it. But for them it could be a six-month process to get that expenditure okayed.” As for the experienced European giants entering the US, he’s “not overly” concerned. “There is nothing wrong with some healthy competition – they know what they are doing and they will partner up but it’s the government’s call on everything. It’s not William Hill’s decisions on anything they want to do, it has to go up the chain.” So, does this offshore trading director find himself tossing and turning in bed at night over the prospect of legalized sports betting sweeping across the US? “I sleep very well at night,” he states calmly. “We’re not worried.”