How Betfair beat the bookies

It was a mundane midweek day's racing at Southwell in January 2002. Family Business, ridden by champion jockey Tony McCoy, was odds-on favourite for the Feast of St Raymond Novices' Chase.

When the horse unseated McCoy at the 10th fence, most punters gave up hope. They then watched, amazed, as one by one the remaining four runners - all of whom had limited steeplechase experience - capitulated, unseating their riders or refusing fences. By the fourth-last fence, no one was left to finish, and the race was about to be declared void. McCoy, who had caught and remounted Family Business, could hear the news over the PA. Having guided him back to the 10th, the pair jumped their way to an unlikely, not to say expensive, victory.

It was a story to bring a smile to the most weathered of punters. And nobody was smiling as hard as the two backers on the Betfair betting exchange, who had each put £2 on the horse after he fell. His "in-running" odds at the time were 999-1. That £2 bet had just returned £2,000.

Twenty years ago, the betting ring still held on to some Runyonesque charm. The bookmakers kept their money in leather satchels, known as hods, hanging from their joints - a metal sheet onto which the odds were written - and stood on wooden stools. Tic-tac men signalled prices and bets from one end of the ring to the other. Inheritance of the pitches was strictly hereditary - would-be bookies had to wait for families to die out to have the chance to price the odds.

It was old-fashioned, for sure, but vibrant. The term "a licence to print money" still applied to on-course bookmaking, certainly on the big days and the bank holidays. And on quiet days, the big bookmakers were able to manipulate the course markets, in particular by shortening the odds on the favourites by placing bets just before the race started. Thus the off-course firms were happy, the on-course firms were happy and the punters, it seemed, had plenty of ready cash to lose.

Then there were the racecourse characters, the minor celebrities who rubbed shoulders with minor villains: the Dodger, Johnny Lights, Jimmy the Wig, Peter the Builder and Tony the Hat. Tick-Up Stan stood outside selling marked racecards. Johnny Raf had been in the Royal Air Force and supplemented his income with a little shoplifting, as did Bob the Dog. Some names were geographically accurate, such as Windsor Ted, but Bristol John was from Birmingham, Manchester Mark was from London, and Geordie Alan came from the north-east but was not a Geordie. There was also a young taxi driver from north London called Paul, known as Paul the Cabbie.

Today, thanks to Betfair, Paul, now 45, no longer tours the streets in his taxi. The betting exchange has changed his life. "I had a passion for gambling from a young age, even at school," says Paul, who prefers not to use his surname. He would have winning runs, yet had to go back behind the wheel to build another betting bank when things went wrong. "But Betfair transformed my life," he says. "The better prices on offer and the fact that I could lay as well as back meant I went from a losing punter, or one struggling to make it pay, to a winning one."

Betfair launched on Oaks Day in June 2000, with a mere 36 people striking bets on the fillies' Classic at Epsom. Since then it has grown into the most influential betting platform in the British market. One of its innovations was to give punters the chance to bet after a race has started, right up to the end of the event. Sure, other bookmakers had experimented with in-running betting, but none could offer, as Betfair could, the chance to bet immediately at the click of a mouse.

Betfair now provides worldwide markets for almost every sport imaginable. But it was on British horse racing that it cut its teeth, and in the process revolutionised the way people go about their business, and pleasure. Instead of going to betting shops or the on-course bookmaker, Betfair's customers conduct virtually all their business online, betting with people they do not know with the exchange acting as intermediary.

The beauty of the idea was that people could now also bet against something happening - and set their own odds. Betfair makes its money by taking a commission ranging from 2-5% from the winning customers after each event.

Betfair's broad appeal was crucial to its success. Winning punters had become frustrated with traditional bookmakers, finding it ever harder to have their bets accepted. Losers - the large majority - found that Betfair, with lower margins against the punter than traditional bookmakers, made it possible for them to lose their money more slowly, or even turn a loss into a profit. Punters could turn bookmaker and set their own odds. And in-running betting was taken to a far more sophisticated level.

To people discovering Betfair for the first time, it seemed that the exchange was all about the punters. The punters set the markets. The exchange's commission meant that Betfair did not care who won and who lost. It was the near-perfect betting platform.

Betfair was born in 1998, when Andrew "Bert" Black met Ed Wray at a party and expounded his idea of a person-to-person betting website. Both men had backgrounds in the City - Black had managed a hedge fund and Wray had been on the trading floor for JP Morgan. It was a time of boom and bonuses, so when they decided to try the idea, raising the capital wasn't a problem.

The key to Betfair's success was to be the first in the business. As punters flocked to lay their own odds, some bookmaking firms, including the biggest of them all, Ladbrokes, toyed with their own exchanges, but Betfair was already too big to take on. In a market where liquidity - the amount of money in the market - is the biggest attraction to potential backers and layers, Betfair had it and the others did not. Soon its prices were forcing the old-fashioned bookmakers to cut margins (and, by extension, profits).

Black, now 45, has always been a punter. If someone else had begun Betfair, he would be betting with them. As it is, he is co-founder of a company that last year had a revenue of nearly £240m and a profit of £30m. Betfair has 1,350 employees and what chief executive officer David Yu describes as "more transactions than all the European stock markets put together". It has branches worldwide (but not in the United States, where internet gambling is illegal). Black himself owns a string of racehorses.

Betfair has changed the racecourse for ever, even though it has, as yet, no pitches or presence at racecourses beyond advertising, sponsorship and hospitality, and no presence on the high streets, where Ladbrokes, William Hill and Coral continue to dominate.

When I first started going racing regularly, in the mid-80s, bookmakers obtained their initial prices - known as the "tissue" - from odds compilers. The big firms had their own tissue men but the racecourse bookies tended to rely on private individuals. Now, Betfair supplies the "tissue", with players offering backs and lays on the site the night before.

And it has created a new kind of gambling careerist. "Now my skill is being able to predict the fluctuation of the markets," says Paul, "and that is down to my history as a punter. I can work out what the punters are going to back, what horses are going to shorten, and what are going to lengthen in price; which jockeys and trainers they follow and which ones they reject. Most of my bets lately have been on market moves."

This method is called "arbing", after the stock-market term "arbitrage". Many punters began operating in similar ways to those in the stock market, "buying" a horse at a high price (backing) and "selling" it back at a lower price (laying). Yet, gradually, the difference between the Betfair prices and the betting-ring prices, allowing people to "arb", has been eroded, with just about every on-course bookmaker taking notice of what happens on what they call "the machine".

Much of Paul's business is done in-running and, as with Family Business, there can be huge fluctuations in price. Paul the Cabbie started out in the era of chalk and wooden stools, but the Tick-up Stans and Johnny Rafs have been replaced by a new generation of traders, most of whom have arrived since Betfair began.

With in-running has come the growth of exchange shops, a more sophisticated form of betting shop, where serious punters pay from £25 to £40 per day for a seat to play the markets, making use of fast pictures direct from the track. People congregate to bet and trade, generally not for recreation, but as a living.

The Cabbie prefers to go to the track, where he can enjoy the biggest in-running edge of all, watching the races live with a telephone link to a colleague on Betfair. But the value is harder to find, he claims. "You are swimming with the sharks now," he says. "Since the advent of exchange shops, much of the value has gone out of the market. But I still believe in-running has not peaked, whereas the pre-race markets have."

This is where the growth of other sports markets comes in. Some long-term professional punters have switched from racing. One of them, Dave Gilbert, now plays on golf and football because "I found that horse racing had become too big to cope with, too many horses, too many races."

Paul agrees: "I think the sports market will continue to grow, whereas the horse market will drop. There were telephone numbers traded on football's European Championship, Wimbledon and the Open golf [in 2008]. People have more opinions on sports than racing. I have been having more sports bets this year than in the previous six. People can bet in pubs, on the mobile, live at the event. It is so convenient, so people are playing on the sports market and not the horses."

For 50 years after the war, the on-course market stood still, until new rules meant that pitches could be bought and sold and computer technology meant that bookies' clerks pressed buttons rather than recorded bets in ledgers by pencil. In Betfair's world, things move faster than ever. It is now possible to attach computer programs to Betfair, run by internet robots, or "bots". People can programme their bot to play a market or to predict the momentum of a market.

Like the bookies, punters who want to stay ahead of the game are constantly having to change their tactics. "When Betfair first started," says Paul the Cabbie, "there were about 20 arbing teams at the track; now there are only two of us left." Gradually, the market for arbing became saturated, so many of the arbers turned to in-running. There is the two-furlong man on his ladder, the furlong man and the man on the line. All different teams, all using different tactics. Not all backing horses to win, but some laying. These are the new racecourse characters: Jimmy the Wig has been replaced by the Betfair Commando, who wears army fatigues; the Dodger by the Undertaker (looks miserable but makes money). Like Paul, Julian Gouder, a large-staking punter from the north-east and one of Britain's biggest players on Betfair's race-day markets, thinks that horse racing markets are close to stagnation. "Where will it all end?" he asks. "I think that the very few opinion-based punters out there will struggle on, trying to make it pay, while the throngs of traders will continue to skim a wage every week and racing will gradually lose its market share to other sports."

For racing in the UK, that is an unpalatable future, for, unlike in other countries, it depends upon the levy contributions of bookmakers and exchanges - originally punters' money - to keep afloat. But the immediate future for Betfair seems buoyant. The company announced in December that it is to sponsor the King George VI and Queen Elizabeth Stakes, one of the most prestigious races in the calendar, at Ascot in July. Not only is it backing the race but, as part of the five-year deal, Ascot will be opening Betfair lounges on the course, "where new and existing customers can experience the thrill of horse racing".

The on-course bookmakers, who have paid considerable sums for their pitches, will not be happy, but there is not much they can do to stop the Betfair behemoth. To visit Kempton Park on a Monday afternoon, or Folkestone on a Tuesday, is to watch the British betting ring in what may be its last throes. Six or seven bookmakers try to drum up business from sparse crowds. I counted fewer than 100 on the viewing steps at a recent Kempton meeting. There were more people there but they were either keeping warm in the Coral betting shop under the stand, in the owners' and trainers' bar, or the glass-fronted restaurant. There were a handful of in-running players, with phone earpieces connecting to their colleagues on "the machine".

Meanwhile, the proper punters were at home, watching on Racing UK with their computer browsers switched to Betfair. To be an on-course bookmaker these days is not in any sense to have a licence to print money. Even on the biggest days at the biggest tracks, it can be hard to make it pay. The expenses amount to around £400 per day. One course bookmaker of my acquaintance, Racing Raymond of Leicester, told me after working in the cheapest enclosure at Newbury's recent Hennessy Gold Cup meeting - a very busy Saturday - that "it was useless. I went home after three races because I was taking about £70 a race." That is taking, not profit.

The golden goose for the on-course layer is all but dead. For Betfair, it continues to lay. And when Ascot's Betfair lounges open this year, you get the feeling they will be the first of many.

Does Betfair help cheats prosper?

Betfair isn't universally loved. There have been criticisms that it is now easier for jockeys, owners and stable staff - who are not allowed to lay their own horses - to pass information and fix races. But unlike traditional bookmakers, Betfair will divulge information about clients' transactions to the horse racing authorities. More than a dozen jockeys in Britain have been banned for passing information, and their bans directly related to Betfair's audit trail.

One of those jockeys was Gary Carter, pictured, who rode Dodona at Lingfield Park in August 2003. Dodona had plenty of ability, although she had won only two of her 33 races, and was entitled to be favourite for the race.

I was at the track and backed Dodona, via telephone, on Betfair. The price went bigger, so I backed her again. When a price goes out, even on a favourite, it is not always a cause for concern.

I figured that some people were looking at Dodona's poor win record, and that was the reason for the drift.

During the race, I formed a different opinion. When Dodona moved into contention, it seemed Carter was not animated enough. She was beaten by a short-head, and would have won had she not received the winning jockey's whip in her face. A stewards' enquiry was called. When that upheld the placings, I put the race in the "unfortunate bet" file.

The authorities took another view. On the day of the enquiry, Carter stressed that Dodona had suffered no interference that affected her chance of winning. But at an appeal, he was adamant that the smack with the whip stopped Dodona winning. He would have known then that even if the result was overturned, it was too late to affect bets struck on the race.

Dodona was one of eight losing horses ridden by Carter that Christopher Coleman, a London tailor, had laid heavily on Betfair. On Dodona alone, he "won" £13,174, having "risked" £95,079. Examination of phone records showed close links between Carter and Coleman, and after a two-year investigation Carter was banned from racing - "warned off" - for passing information. Coleman's existing ban was extended indefinitely.

Pre-Betfair, an incident like this was less likely to happen - but more likely to go undetected. The suspicion remains that "insiders" are benefiting.