Chris Stewart is the CEO and cofounder of Suredbits, a bitcoin-settled derivatives platform.
Discreet log contracts (DLCs) are a way to do peer-to-peer betting directly on Bitcoin. You can make these contracts contingent on an oracle’s attestation about a real-world event. This real-world event could be the winner of a presidential election, the BTC/USD price on a cryptocurrency exchange or the outcome of a sporting event.
A simple example is betting on the outcome of the Super Bowl. The Super Bowl this year was between the Cincinnati Bengals and the Los Angeles Rams. With discreet log contracts, Alice and Bob can bet on the Super Bowl by making a bitcoin transaction between them. The funds locked in the bitcoin transaction become unlocked when an oracle attests to the outcome of the Super Bowl.
This article is going to explain why discreet log contracts add value to the existing sports betting ecosystem by giving sports bettors the best odds possible for their bet while not moving the lines.
Understanding “The Vig”
The vigorish (“vig” for short), also known as “the margin” or “the house edge,” is a mathematical advantage introduced by sportsbooks to guarantee they will always profit over the long term. When giving customers odds, the sports book will introduce a statistical bias for a percentage of profit they want to capture independent of the outcome of the underlying game. This is why sportsbooks are so profitable: if they run their business with appropriate risk management, they can’t lose!
The suckers in this example are the customers of the sportsbook. They are at a mathematical disadvantage from the start. If they keep participating in bets where this mathematical bias is built in against them, they are guaranteed to lose unless they have some sort of other edge.
With Bitcoin and discreet log contracts, we can eliminate the vig and construct bets with fair odds. This increases profitability of a sports bettor over the long term.
Recreational Versus Professional Sports Betting
As mentioned above, if you bet against a sportsbook you are guaranteed to lose due to the mathematical bias introduced against you, unless you have an edge. An edge just means you have an advantage against the sportsbook.
A few examples of developing an edge are computer systems that run statistical analysis to calculate better odds than the sports book, or perhaps you have contacts that give you information about the event that is not public. (The latter is frowned upon.) Recreational sportsbooks despise customers that have an edge on them as it means they will lose money despite the vig.
There are two distinct categories of sportsbooks, and they handle customers that have an edge differently.
Recreational sports betting outfits are what you see on your TV during sports events. Their goal is to attract retail customer flow. They make money by giving these retail customers terrible odds (the vig). Retail sports bettors aren’t price-sensitive to odds, they want to enjoy the thrill of betting rather than making money.
For anyone that has an edge, the retail sportsbook will just kick them out. They aren’t trying to compete by calculating the best odds possible, they want to attract as many uninformed bettors as possible.
Many profitable sports bettors are kicked off of recreational books. This is because a recreational sportsbook’s core competency is marketing, not being smarter than the bettors using their book. As books become larger, they must become smarter. Since they are taking the opposite side of every trade on the platform, the sportsbook must have an edge over their customers or else they will lose money.
Market makers set the line to be as competitive as possible. If they set this line to be as competitive as possible, they will organically attract volume from bettors that have a viewpoint on the outcome of the game. They still must introduce a vig to guarantee their operation is profitable, thus giving their customers unfair odds.
Market makers thrive on bet flow. Their business model relies on analyzing bet flow coming into their business. This is very similar to how companies like Citadel work in traditional finance. Citadel pays retail brokerages like Robinhood for their retail flow. The reason they do this is because they get valuable information about the market.
This information gives market makers a leg up on other bettors on the platform, as they know who is placing what bets. They can track profitable bettors on their platform and use their data and adjust the lines they offer to the rest of the book. This enhances the market maker’s profitability.
Customers of market makers are much more technically sophisticated than recreational sportsbooks and are more price sensitive to vigs as they understand that they are mathematically disadvantaged on sportsbooks. Since these customers are more sensitive to price, the market maker is compensated by a small vig plus valuable information about the market.
Customers of market makers are an ideal customer for discreet log contracts as they value the fair odds, the privacy offered by DLCs and the immediate payouts in the form of bitcoin. Since DLCs aren’t recorded on a centralized platform, placing large bets will not move betting markets. This is very similar to traditional finance where two entities agree to exchange a stock or derivative over the counter (OTC). The benefits of OTC trades are that you can exchange large quantities of the financial product, and you can do it privately.
There are sports bettors across the world that want to bet a large amount of money. This is illustrated in the cult classic “Two for the Money” starring Matthew McConaughey.
In this clip, “Mr. Novian” is a high-end sports bettor that bets millions of dollars each game. He is constantly seeking edges provided by analysts like “John Anthony” who is portrayed by Matthew McConaughey.
As mentioned earlier in this piece, recreational sportsbooks do not like customers that have an edge over them. This can result in the sportsbook being unprofitable. High-end sports bettors pose two problems for recreational sportsbooks:
Paradoxically, market makers love sophisticated bettors due to the compensation they receive in the form of information. However, even sophisticated market makers can get run over by large sophisticated bettors.
Because of this, the sportsbook must protect themselves against highly-sophisticated large sports bettors by implementing “per click limits.” This means if Mr. Novian wanted to bet $1,000,000, he would have to slice it up into ten bets of $100,000 each.
To make things even more unfair for Mr. Novian, the sportsbook may adjust the lines after each $100,000 bet he places so that the book can guarantee that it is profitable. This means Mr. Novian will get worse and worse odds as he puts his $1,000,000 bet down.
With bitcoin and discreet log contracts, Mr. Novian can bet any size that he wants. There are no “per click” limits. As long as he can source a counterparty for his bet, he can get consistent odds across his $1,000,000 he wants to bet. This drastically improves Mr. Novian’s odds for his sports bets.
Bitcoin has already affected the sports betting industry. It is the easiest way to send money in and out of any sportsbook regardless of your geographical location. The next revolution for sports betting in bitcoin is discreet log contracts.
The advantages that DLCs and bitcoin provide are:
Thank you to critical contributors from btctldr.com and Play 4 Advantage LLC for insight into the sports betting industry.
This is a guest post by Chris Stewart. Opinions expressed are entirely their own and do not necessarily reflect those of BTC Inc. or Bitcoin Magazine.