An Intro to Blockchain: Crypto Casinos & Sportsbooks

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Introduction

Aside from “Artificial Intelligence”, the most commonly overused and least understood term heard in keynote presentations and fundraising pitches alike has to be “blockchain”.

Perhaps there is good reason for this. It’s a compelling technology with widespread applications, one of which is the deployment of cryptocurrencies such as Bitcoin, of Winklevoss Twin and many a 21-year-old Lamborghini driver fame. Blockchain is also a particularly nuanced and complicated concept to truly get a grasp on, which is exactly what we will need for this discussion.

You may have heard of or even played at a “blockchain sportsbook” or “bitcoin casino.” To be clear, these are not operators that accept cryptocurrency as a method of transferring funds, but rather ones that are actually built onto this thing called a blockchain. Parenthetically, they tend to accept Bitcoin and sometimes other cryptocurrencies as well, but that is incidental to the way they have been named.

To properly understand the benefits and limitations of deploying blockchains in the world of iGaming, we will need to make sure we properly understand what exactly a blockchain is and why it is talked about so frequently in a multitude of different industries. Ultimately, a blockchain is nothing more than a really good way to store data, but we’ll try to do better than leaving it at that.

WARNING: OVERSIMPLIFICATIONS AHEAD

Blockchain Basics

Often, when people speak about blockchain, we hear them mention a distributed immutable ledger. It’s incredible how much we can understand about the way the technology operates by breaking down this term and using a few examples.

  • Distributed — Stored in multiple places at the same time
  • Immutable — Unable to be altered
  • Ledger — A record of events, typically financial in nature

Thus, what these people are saying is that blockchain is a way to take a (digital) record and then store multiple copies of it in different locations, so that even successfully changing one of the copies won’t compromise our record keeping abilities.

Imagine you had a picture saved on your computer that was extraordinarily valuable to you. If you wanted to make absolutely certain that you always had access to it, you might consider backing it up on an external hard drive or uploading it Dropbox or Google Drive. If you were extremely worried about the image getting lost, you might choose to also store a copy on your phone and email one to your friend so that they can keep a copy on theirs.

You probably would not only be upset if the picture got stolen, but also if it was altered in any way such that it was no longer the same image. If you were really paranoid, you might choose to save a copy of the image to a USB drive and store that in a safety deposit box. If you were a double agent working for the CIA, fearful that a sophisticated nation-state actor would try to hack into your computer to digitally remove their trained sniper’s face from the background of the image before you identify them, you might choose to save copies on a few hundred different USB drives and scatter them in safety deposit boxes all over the world.

The decentralization of the information you are storing is precisely the source of the security with which it is stored. In other words, there is no singular point of attack through which information can be compromised, so hackers would need an impossibly massive and coordinated effort to alter all of the photos successfully. If they only alter one, or even a few, the majority will remain with the original image and sniper’s face intact.

In perhaps a dangerously-oversimplified analogy, a blockchain is really a digital manifestation and implementation of this process.

The Role of Trust & Fairness

Anyone who has ever played in an online casino, especially one operating in an unregulated fashion, may be familiar with the sneaking suspicion that they are being digitally dealt the exact sequence of cards intended to maximize their total loss. Perhaps you’ve played online blackjack and doubled down on an 11 against a 4, only for the dealer to pull a six-card 21.

If we were to suspect a particular online casino of such trickery, we may demand to see the digital records that they keep, reflecting the history of cards dealt. Since a standard deck of cards contains four of each of the 13 card values (2, 3, 4, 5, 6, 7, 8, 9, 10, J, Q, K, A), one would expect the distribution of cards dealt over any sufficient sample size to be uniform. In other words, 1/13 (~7.69%) of the cards dealt after playing enough blackjack hands should be Jacks, another ~7.69% should be Queens, and so on.

We can see the effect of the Law of Large Numbers here by running a simple simulation where we deal 10,000 cards and calculate the frequency distribution, and then do the same for 100,000 and 1,000,000 cards.

At first glance, when graphing our results, it seems that increasing the sample size is actually increasing the variability in outcomes. However, that’s only because the x-axis has been deliberately manipulated in each chart to seem as such, in a thinly-veiled attempt to promote people more carefully reviewing the statistics that are presented to them.

When we use the proper scaling on each chart’s axis, we can see the trend we would expect…

…overlaying a red dotted line at the ~7.69% mark even further illustrates this point…

…as does looking at the data in table form and comparing standard deviations…

To this end, if you were to audit the historical blackjack hands dealt by the online casino that you suspect of wrongdoing, and found that Kings and Aces only occurred with frequencies of 2.00% over a sufficient stretch of time, you would now have a much stronger case against them. Of course, there are more complex but identifiable types of disproportion that can be uncovered with basic statistical methodologies.

However, if the audit reveals results perfectly in line with the expected distribution, you may then wonder if this online casino, the only party with access to this data and the ability to verify its validity, may have retroactively altered the ledger showing the cards dealt, before submitting it for auditing.

Particularly when it comes to dealing with foreign entities that operate in unregulated markets, trust can be a major issue. We can very quickly realize that trust is one of the most important facets of the processes that enable life as we know it, particularly those purveyed by corporations.

The Role of Trust in Traditional Banking

When you deposit $100 into your Chase checking account, you can immediately check your balance and see that it is in fact $100 greater than it was previously. But, how do you know that the balance will still be at this level the following day? Couldn’t someone hack into the Chase server and divert $10 to their own account, then alter the records so that your new balance is only $90 higher? After all, what is your checking account balance beyond an entry in a digital ledger, among a number of other entries reflecting the balances in other accounts? If someone with such hacking skills and inclinations had the time and motivation, they could spread the $10 disparity across all of your historical transactions, making it quite difficult to trace, let alone prove.

The real reason why you generally do not worry about this stems from trust. You can trust that Chase has:

  • Robust cyber security protocols and ample resources dedicated to protecting customer funds
  • A policy from the Federal Deposit Insurance Corporation (FDIC), insuring your balance up to $250,000 against theft
  • An economic incentive to comply with banking regulations, follow the law, and provide customers with comfort, so that they can retain these customers and continue acquiring new business

In the absence of this type of trust, a blockchain’s mechanism for rendering a ledger or digital record to be immutable by distributing copies of that record across different locations is incredibly valuable.

Counterparty Risk

There is another type of risk, however, that we should be concerned about when placing our hard-earned money in the custody of others. How do we know that the individual or entity on the other side of our transaction will be operational and financially solvent when we need to withdraw our funds? In the investment world, counterparty risk represents the likelihood of exactly such an occurrence whereby the opposing party defaults on their contractual obligation.

Imagine you placed a wager on an event that would not be settled for 10 years (e.g. “New York Jets — Over 1.5 Super Bowl Wins — Next Ten Seasons”). You would have had to deposit your amount risked at the outset. Seeing as the Jets have only won a single Super Bowl (half a century ago) and seem to have a knack for squandering every bit of talent and opportunity they come across, this would likely be a longshot bet, perhaps paying out odds far in excess of +10000 (100:1). At odds of exactly +10000, a $25 wager would stand to win $2,500. However, this payment will not be made for another 10 years. If other customers have incredible success with longshots in the meantime, sports betting is outlawed, or a global flu-like pandemic shuts down the economy, it’s possible that the operator with which you placed this wager, your counterparty, will be insolvent by the time your bet grades, leaving you unable to collect the funds you are due in the event that you win.

We can imagine that bettors wagering on there being a 10-person base established on the Moon by November 14, 2024 may already be having similar concerns…

Source: Pinnacle

…as might those laying almost $50,000 to win $100 on the proposition that there will not be a consensus that the earth is flat by January 1, 2025…

Source: Pinnacle

But, we digress…

How can we trust that a sportsbook will still be willing and able to pay our winnings in a future that is subject to stochastic uncertainty, not to mention poor decision making? In any financial transaction, how do we protect our funds when a deal may be in limbo?

Anyone who has ever purchased a house is likely familiar with the concept of escrow, where the buyer’s funds are placed in the custody of a third party until specific conditions are met.

This concept has been modernized and adapted by sites like eBay and StubHub in order to bolster the integrity of the transactions that take place on their platforms. On eBay, for example, a buyer’s funds are often kept in a veritable digital escrow and not released (by PayPal) to the seller, until the tracking number uploaded by the seller is marked as “delivered.”

On StubHub, oftentimes the buyer’s funds are not released to the seller (also by PayPal), until the seller has uploaded a .pdf file containing the tickets being sold. When the original tickets were purchased via Ticketmaster, there is often a similar verification process as exists in the eBay user flow.

These are great features, assuredly, but still suboptimal. For example, the eBay system can be circumvented by simply uploading the tracking number for a package containing worthless items that gets delivered to the address of the winning bidder.

The StubHub system can be subverted by sending tickets to a buyer but then printing those same tickets (with the same barcodes) and entering the event before the buyer arrives. Also, in both cases a third-party (in this case, PayPal) needs to play a role in the ecosystem. This is almost always the case, particularly as payment processing is typically an outsourced or white-labeled functionality.

Ensuring Payment on Long-Dated Wagers

How might we use this concept to ensure that we get paid on our New York Jets Super Bowl prop ten years from now? If our counterparty has to place their funds into a digital escrow account that will survive their own dissolution, we don’t have to worry about bankruptcy. But, we still may worry about obtaining the funds. Imagine if we took the digital escrow instrument and layered on a mechanism for automatically transmitting the funds to respective parties pending pre-defined events taking place. Visually, our automatically-executing digital escrow transaction mechanism might look something like this:

Let’s sort through what’s going on here:

  • Bob wants to risk $25.00 on the proposition that the New York Jets win more than 1.5 Super Bowls over the next 10 seasons. He will deposit that $25.00 into a digital escrow account.
  • DraftKings, Bob’s counterparty, is offering this proposition at odds of +10000, meaning Bob would win $2,500.00 if the Jets miraculously win 2 or more Super Bowls between now and the 2030 season. DraftKings will deposit $2,500.00 into the digital escrow account so that Bob is certain the funds will be available in the event that he wins the bet.
  • A small bit of code is added that directs the account to transmit the funds to either Bob or DraftKings once the contract has expired, based on the number of Super Bowls won by the Jets over that period.

Fortunately, we don’t have to create this automatically-executing digital escrow transaction mechanism from scratch, because it already exists and is called a Smart Contract.

Smart Contracts

Of course, the “code” above is oversimplified and barely passes as pseudocode. Additionally, it makes no mention of the source of information to be used in order to verify the outcome of the underlying event. A massive event like the Super Bowl will generally be reported to have the same exact outcome regardless of what source we reference.

However, games played with less visibility may be harder to verify, particularly as the details sought become increasingly granular. Amidst the current global pandemic, many people have been betting on Belarusian hockey and Nicaraguan soccer, often relying on foreign sites with delayed scoreboards to track the progress of games and ensure bets are graded properly. Even many of the largest sports media outlets in the United States sometimes, at least temporarily, report incorrect scores. In fact, a Reddit user recently showed that he was able to manipulate the reporting of the first half score of an NCAA Basketball game simply by using Twitter to convey a falsified play-by-play and truncated box score.

When computers will be automatically executing instructions that impact the lives of human beings, it is essential that the logic built in for doing so does not give rise to unintended results or opportunities for exploitation. People in the world of blockchain use the phrase “code is law” to describe the fact that, once set in motion, an automated process will not yield to anything aside from its own programming.

There is a classic joke intended to convey this point:

A programmer is going to the grocery store and his wife tells him, “Buy a gallon of milk, and if there are eggs, buy a dozen.” So the programmer goes, buys everything, and drives back to his house. Upon arrival, his wife angrily asks him, “Why did you get 13 gallons of milk?” The programmer says, “There were eggs!”

This is relevant to our discussion because the use cases for blockchain within sports betting often rely upon a process by which event outcomes are verified and disputes are resolved.

One option being considered by those seeking to deploy Smart Contracts in the sports betting space is to use a fundamental blockchain concept and have a community of users vote in cases where outcomes are being challenged. For example, if you and I were both participants in a peer-to-peer betting exchange that utilized Smart Contracts and we disagreed as to the outcome of the event on which our wager is predicated, the other users of the exchange could be asked to vote and majority could rule.

There are a number of other nuanced complications that can arise from the search for a source of truth or “oracle” to use in the arbitration of disputes, but the loopholes offered by current implementations of the digital escrow structure are much more susceptible to exploit by unsophisticated actors with limited resources.

A Word on Cryptocurrency

So, we’ve been talking for a while now about blockchain, yet haven’t even touched upon the topics of Bitcoin and cryptocurrency.

Cryptocurrency is just one of the many ways in which blockchains can be implemented, and Bitcoin is just one of the many cryptocurrencies that exist.

In other words, blockchain is the structure that underpins all cryptocurrencies, including Bitcoin. Specifically, it plays the role of the ledger that records all of the transactions (and therefore balances) across all currency-holders. One of the reasons for which Bitcoin and blockchain are thought of in such an inextricable way is that blockchain was invented by a mysterious person (or, perhaps, group of people) under the name Satoshi Nakamoto, specifically to serve as the public transaction ledger for the Bitcoin cryptocurrency.

If you are not interested in a deeper discussion about Bitcoin and the viability of cryptocurrency as means of transferring value, feel free to scroll down to the section titled, “Closing Thoughts.”

A Word on Bitcoin

Terminology sometimes gets confusing, particularly because the Bitcoin cryptocurrency (BTC) is built on the Bitcoin blockchain, just as the Ethereum cryptocurrency (ETH) is built on the Ethereum blockchain. Ethereum was the first alternative to Bitcoin, and differentiated itself by supporting Smart Contracts and Decentralized Applications (DApps). There are approximately 3,000 other cryptocurrencies in circulation, though they do not all have their own dedicated blockchain. For example, FunFair is a decentralized gaming platform powered by Ethereum smart contracts, that has its own token (FUN). As of the time of writing, the total market capitalization of all cryptocurrencies in circulation was approximately $175bn.

The prefix “crypto-” is used because the process by which transactions within the network of a particular currency are recorded and validated, and thereby permanently stamped onto the distributed immutable ledger, involves mathematical computations that borrow from the field of code breaking or cryptography.

Characteristics of Money

An interesting debate has persisted as to whether cryptocurrencies are truly substitutes for money. Aristotle had famously outlined four key characteristics, all of which needed to be fulfilled in order for a means of value to serve as “money.”

  1. Durable — It must be able to stand the test of time.
  2. Portable — It must be easily moveable and hold a large amount of value relative to its size/weight.
  3. Divisible — It should be easy to break into smaller pieces (and reassemble) without ruining its basic characteristics.
  4. Intrinsically Valuable — It should be valuable in and of itself, with value completely independent of any other object.

However, these criteria were outlined over 2,000 years ago. The world is very different today and in ways that specifically change the requirements a society places on a monetary system.

The increase in mobility offered by modern technology has necessitated inventions like, for example, checking accounts and checkbooks. Writing checks allows bank customers to transfer enormous amounts of value directly from their account into that of a merchant or vendor, typically in exchange for goods or services, without worrying too much about theft and security. Since a check only has an intrinsic value equal to the cost of the paper it is printed on, losing one is relatively inconsequential. A quick call to the bank and that check will be cancelled, leading to a loss of essentially nothing. However, with just a pen, one can transfer millions of dollars elsewhere using that same check.

When you think about it, even cash, often considered the most pure form of “money” does not have much intrinsic value. In fact, a $100 bill is only worth more than a $1 bill because each person who possesses it believes that the next person will value it just as they do. Additionally, most currencies are backed by the “full faith and credit” of their issuing government, which helps reinforce the faith people place in the ability to use that currency for transferring value.

The group of currencies whose value as legal tender is rooted not in intrinsic value but in the full faith and credit of a government are known as “fiat currencies.

According to the St. Louis Fed, there are actually six characteristics which must be fulfilled in order for a system to be considered “money” today. We notice quickly that the first three are the same as those posed by Aristotle, with the other three replacing his requirement of intrinsic value.

  1. Durable — It must be able to stand the test of time.
  2. Portable — It must be easily moveable and hold a large amount of value relative to its size/weight.
  3. Divisible — It should be easy to break into smaller pieces (and reassemble) without ruining its basic characteristics.
  4. Uniform — Units of the same denomination should be generally identical in nature and, therefore, fungible.
  5. Scarce — Units must have a limited supply in order to maintain value.
  6. Acceptable — Units must be universally accepted as vehicles for transferring value.

It seems that a very convincing case for Bitcoin as money can be made. On May 22, 2010, Laszlo Hanyecz succeeded in paying 10,000 Bitcoins for two delivered Papa John’s pizzas. This day has since become known as Bitcoin Pizza Day. At current prices, those two pizzas would currently be worth $63.1mm. When Bitcoin’s price was at its highest, on December 17, 2017, they would have been worth $197.8mm.

We can quickly run Bitcoin through all six of the St. Louis Fed’s tests:

  1. Durable — Bitcoins are virtual representations of value that cannot be destroyed, though access to them can be lost.
  2. Portable — Bitcoin weighs essentially nothing and allows for a virtually unlimited amount of value to be carried on something as small as a piece of paper.
  3. Divisible — While a Dollar, Euro, or Pound can be split into 100 units, a Bitcoin, by design, can be split into one hundred million (100,000,000) units.
  4. Uniform —Bitcoin is perfectly uniform, though there is debate as to its fungibility.
  5. Scarce — Bitcoin uses mathematics to cap the total possible supply at 21,000,000 (there are currently ~18mm BTC in circulation)
  6. Acceptable — The rise of exchanges, user-friendly mobile applications, Bitcoin ATMs, and other technological phenomena along with sociopolitical considerations has caused Bitcoin to rise to one of the most accepted currencies in the world.

Going through a similar exercise with dollars or gold may reveal some insights into where you stand on the debate of cryptocurrencies serving as a real replacement for money.

Crytpocurrencies have often been drawn synonymous or parallel to illicit activity and dark web dealings. However, there is nothing inherently illegal or evil about the underlying technical infrastructure. In fact, some governments and central banks have begun discussing the possibility of operating blockchains and cryptocurrencies within their daily operations.

The chart below shows how a Central Bank Cryptocurrency would amount to a decentralized virtual representation of value purveyed by a monopolistic entity, as well as how that compares to other forms of value exchange.

Source: St. Louis Fed

Cryptocurrency Realities

Cryptocurrencies can offer, among other things, anonymity, which can be good or bad, or sometimes both. That said, the safety of the digital wallets in which crypto fortunes are stored are only as safe and reliable as those who hold the key needed to access them.

Without getting unnecessarily technical, the most important aspect of maintaining the security of a Bitcoin wallet typically concerns how we protect our password. The account itself is generally regarded as impenetrable, unless someone obtains our “private key.” Because of this, people go to incredible lengths to store passwords in secure ways. Not only this, but they often use very long passwords with the largest variety of characters possible. Some have reportedly gone as far as to write the password down on a piece of paper, cut it into multiple smaller pieces, and placed each piece into a safety deposit box in a different bank in a different state.

Still, it is estimated that 20% of the Bitcoin value that is ever created will be lost permanently due to misplaced passwords or private keys. As of the time of writing, that would be over $20,000,000,000 ($20 billion) worth of Bitcoin. The reason for this is directly related to the underlying security of a Bitcoin wallet — without the password, it is virtually impossible to access.

People often use the phrase “cold storage” to describe the process of saving private keys on devices that are never connected to the internet in order to provide maximum protection from malicious actors.

This facet of the ecosystem has given rise to a number of interesting stories in which the owners of crypto funds or exchanges go mysteriously missing, along with all of the assets under management, never to be seen or heard from again.

Closing Thoughts

We started out this discussion by noting that a blockchain casino or sportsbook is not one that merely accepts cryptocurrency deposits. Rather, it is one that is actually built onto a blockchain. Now that we’ve gone through an introduction to key concepts, we can understand what applications are within reach of the market and what limitations might exist. Specifically, we can examine this first as relates to provable fairness and then as pertains to Smart Contracts.

Provable Fairness

Online casinos are perfectly suited to employ a blockchain that helps assure customers that games are not rigged. In fact, some already do.

Traditional sports betting does not clearly benefit from the concept of provable fairness. However, DFS contests and sweepstakes functionalities within operator ecosystems potentially could.

Smart Contracts

From a value-add standpoint, the use of smart contracts in online casinos is quite appealing to users. However, the operations can be prohibitively capital intensive. We can take the example of a roulette spin to illustrate this.

On the roulette table above, we see a variety of $1, $5, and $10 bets have been placed on the table. Imagine that every individual chip has been placed by a different customer, according the following payouts:

  • Red/Black — 1:1
  • Odd/Even — 1:1
  • Column — 2:1
  • Third–2:1
  • 4-Way Corner — 9:1
  • 2-Way Split — 18:1
  • Single Number — 36:1

We can see that there are a total of each of the following chip denominations…

  • Blue ($1) — 10
  • Yellow ($5) — 14
  • Gray ($10) — 12

…meaning, a total of $200 has been risked on the table.

Suppose Black-2 comes up. What would the payouts be?

  • The yellow $5 chip on the number 2 would pay 36:1 — $180
  • The five blue chips on black would pay 1:1 — $5

A total of $185 needs to be paid. Fortunately, only $10 worth of the chips on the table were associated with winning bets, meaning there is actually $190 with which the casino can pay out the $185 in winnings, leaving $5 of profit.

However, imagine we wanted to use fully-funded, digitally-escrowed smart contracts for every single wager placed. Every $10 wagered on a specific number would require a $360 deposit on behalf of the operator. In fact, the hypothetical chip layout we used above, which required $0 in extra cash to operate in the traditional sense, would require a whopping $2,716 deposit into a variety of smart contracts, just to make that same $5 profit.

  • $38 on Numbers @ 36:1 = $1,368
  • $51 on Splits @ 18:1 = $918
  • $36 on Corners @ 9:1 = $325
  • $25 on Thirds @ 2:1 = $50
  • $5 on Columns @ 2:1 = $10
  • $35 on Red/Black @ 1:1 = $35
  • $10 on Odd @ 1:1 = $10

The same thing can be said for fixed-odds sportsbooks. You can read more about bookmaking economics here, but may recall that these operators make money by incentivizing a risk-minimizing proportion of wagers on either side of a given market, so that profit is as close to guaranteed as possible.

In the example above, the sportsbook does not need additional cash on hand to process the wager. This is because, regardless of the outcome of the event, there will be enough losses to fund the payments due to the winner.

If, instead, the operator sought to use smart contracts in the way we have described, they would need to deposit $290, all to potentially have $0 in profit. This would be the $190 deposited into a smart contract in case Alice wins and $100 deposited into a smart contract in case Bob wins.

For peer-to-peer (P2P) betting exchanges and platforms, however, a smart contract is incredibly useful. This is because the bettors are already supplying all of the cash and are transacting it with one another. Any capital requirements would befall the users and not the operator, who just seeks to maximize liquidity and transaction volume. In the P2P context, smart contracts allow for guaranteed and instantaneous payouts, which could be a major point of differentiation compared to an operator that does not offer such functionality.

Conclusion

Blockchain is a rapidly emerging technology with widespread applications across industries, only one of which is the deployment of cryptocurrencies. Blockchains provide enhanced security and faster payment processing, as well as transparency and decentralization, all of which can add value in the online gaming industry. It is important to understand not only the strengths but the limitations of the technology as well when deciding whether it makes sense for any particular venture.


An Intro to Blockchain: Crypto Casinos & Sportsbooks was originally published in Coinmonks on Medium, where people are continuing the conversation by highlighting and responding to this story.