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Random Thing I Think I Think: Gambling, Investing, Luck & Skill Edition

Have you seen the commercials for fantasy sports gambling leagues like FanDuel or DraftKings?  They’re everywhere. In case you’ve been in your bunker waiting for China to implode the global economy – these are basically ways of gambling on sports via the label “fantasy sports”.  These firms are raking in huge amounts of money through a legal loophole that differentiates between sports gambling and gambling on fantasy sports based on the idea that fantasy sports involves “skill”.  The wise readers of Pragcap probably know this already, but if you think that gambling on fantasy sports is your fast track to the rich house then I suggest you hire someone to separate you from your money before one of these firms does it for you.

Gambling and investing are often compared to one another.  And for good reason – they have many similarities.  In fact, I compare the two in my book and regularly on this website.  But we should be very clear about these two forms of capital allocation.  Gambling is placing capital at risk in a zero sum game with an uncertain outcome in a system in which the odds are generally unfavorable over long periods of time.  Investing, on the other hand, is placing capital at risk in a positive sum game with an uncertain outcome in a system in which the odds are generally favorable over long periods of time. Gambling doesn’t make us all wealthier over the long-term.  It simply shuffles money from some players to others with a negative friction in the middle. Investing is a positive sum game in the long-run because it is a way of benefiting from the growing wealth of the aggregate economy.  That is, financial assets tend to become more valuable over time because they are a function of underlying economic productivity and growth.  A gambling pool grows because greater fools join the pool while the financial asset pool grows because the underlying output of the economy becomes more valuable.

This brings us to the idea of luck versus skill in capital allocation.  I’d argue that investing is a game of skill with a substantial element of luck.  And according to the Unlawful Internet Gambling Enforcement Act of 2006 Fantasy Sports is different from something like online poker or sports betting because it is a game of skill:

“has an outcome that reflects the relative knowledge of the participants, or their skill at physical reaction or physical manipulation (but not chance), and, in the case of a fantasy or simulation sports game, has an outcome that is determined predominantly by accumulated statistical results of sporting events, including any non-participant’s individual performances in such sporting events…”

I would describe fantasy sports as a game of skill with a substantial element of luck whereas something like poker is a game of luck with a substantial element of skill. The best poker players in the world can’t display much skill if they don’t get the right cards. But online poker has been deemed an illegal game of luck/skill whereas fantasy sports are a legal game of skill/luck.²

The idea of “skill” versus “luck” in these games is a pretty gray area though.  And because of that I think it’s difficult to deem whether one should be illegal or not on those grounds alone.  Further, we play lots of inherently negative or zero sum games all the time though they serve various purposes ranging from forms of insurance, business hedging to pure entertainment (for instance, currency markets, commodities markets, your friendly neighborly wager on useless stuff, etc). A currency market is a form of gambling according to my definition, but it’s one that serves a vital social purpose by allowing businesses and individuals to make markets in foreign exchange. In addition, this form of gambling is highly transparent and fair even for those who engage in it for entertainment purposes.

Online poker or fantasy sports clearly doesn’t serve a higher social purposes like a currency market does.  These leagues exist purely for entertainment purposes.  Therefore, the legality of these services has more to do with whether they unjustly prey on the ignorance of their participants in providing their social service of friendly entertainment.  In the case of online poker the government clearly determined that it was impossible to regulate away the manipulation which means it made sense just to ban it. The fantasy sports leagues are a much more transparent and level playing field (as far as these uneven playing fields go).  You know when the Nationals crapped the bed because that’s what they do every night.  What you see is what you get. No one is manipulating the card shuffling algorithm against you.

On the other hand, these leagues don’t appear to be offering that much entertainment or monetary benefit for their users.  According to Les Bernal of StopPredatoryGambling.org, “Ninety percent of the money that was won in FanDuel and DraftKings was taken by 1.6 percent of the players”.  When the winners are so disproportionate you have to wonder whether these games are good clean fun or ponzi-like financial schemes that prey on the ignorance of greater fools.

In my mind if you understand that gambling on poker is a negative sum game and decide to do it then that’s your prerogative.  I don’t think the government should deem poker illegal just because you decide to do something that is not in your best interests.³  Likewise, if you know you’ll very likely lose money betting on fantasy sports, but you decide to play nonetheless, then, as the old saying goes, a fool and his money are soon parted.  But these fantasy sports games don’t resemble something like a skilled game of negative sum poker.  They appear to resemble something more like lambs to the slaughter.

The bottom line is, the existence of these games bothers me because I know that millions of people play them and the vast majority of those people don’t benefit.  They appear skewed in a way that resembles a scam more than anything else. They’re not making society wealthier as a whole or better off in any way.  They’re just shuffling money from greater fool to greater fool before it reaches the minority of owners and sharks.  Of course, the key to playing these games is to not be the greater fool.  That is, if you enter an anonymous online room and you can’t identify the patsy then you are the patsy.  And in a room where you can’t see your competitors the only way to avoid being the patsy is to not enter the room in the first place.

¹ – Don’t read this boring section of US Code 5361.

² – In fairness, many of these online poker sites were manipulated to tilt the odds in the house’s favor.  

³ – The irony of the government deeming some gambling “legal” or “illegal” should not be lost on us. After all, they run the largest gambling scam in the world – the lottery systems.