The Problem of Measuring Effective Rake

In his essay Measuring Value Nick Szabo points out, “Money, wage labor, markets, and many other economic institutions take the forms they do primarily because they solve problems of measuring value. Such questions also lie at the heart of the current crisis in accounting”.

Poker has is own value measurement problem. “The profitability in terms of “effective rake” is hidden on every site by many contributing factors. The most significant are the make-up of the player field (winning players vs depositing players), and the winning distributions. These factors are not definable for the players community.” Here we define effective rake as:

A winning player might exchange 5USD on site A with an a roi of 5%.
The same player deposits 5USD on site B with an roi of 4%
We say that the “effective rake” on site B is higher than site A.

In order to solve the issue of measuring the value of the exchange of a players money for chips on a given site we must begin to consider the ideal:

In the ideal market, supply balances demand resulting in a price that incorporates all the relevant skills and preferences of the market’s participants. In such a market, this balance between skills needed to create a commodity and the preferences for that commodity constitute the value of that commodity — we can measure value by the equilibrium market price.

However the inability to properly evaluate effective rake renders the service:

In the competitive market, one commodity is traded for another. (Money is just a particularly interesting kind of commodity). In order for this market to work — in order for prices to accurately communicate value — first the participants must be able to measure the value of the two commodities traded. Indeed, that’s the main property that distinguishes a commodity from a less economically tractable good or service — the ability of parties to measure its value — the ability of parties to observe properties of a good or service, matching what they observe against their private preferences, and making sure this process isn’t spoofed by wily traders.

What becomes increasingly more important is the perspective of the “cost of transaction”:

They are working backwards from a very clear theory of competitive markets to explain the wide variety of other kinds of economic relationships, usually formalized by property rights and contracts, that we enter into. This school is most widely known as the “transaction cost” school of economics.

By taking this view we are able to under stand the “centralized” site model and economic conditions players face today:

By comparing a wide variety of contractual forms to the ideal commodity market, and by re-using many of the same assumptions used by neoclassical economists — individuals with rational self-interest, unique preferences, and unique skills — we are better understanding these other economic institutions.

We can understand these as 1) cost of security provided by third parties (sites) 2) arbitration that players might others have to execute themselves, unforeseen “glitches” in over all player experience 3) The complete cost of cashing out, downloading and installing new software, setting up a new account, depositing, learning new software etc., all mental transactions included.

These economists have identified a number of limitations of ideal commodity exchange that often cause other contractual forms to be used instead. These include:
(1) security costs.
(2) rule incompleteness — the difficulty for parties to anticipate all contingencies that might occur in a relationship, and thus the inability to plan for them with rules (for example, by terms in a contract). Most disputes that go to court, and most interesting new legal precedents, occur over situations that the parties entering into a relationship didn’t foresee well enough to deal with up front.
(3) exit costs and/or investments that are specific to a particular relationship. For example, when you take a class to learn how to use Windows or Word, you are investing in a relationship with Microsoft.
(4) We will shortly turn to perhaps the most important kind of transaction cost, the measurement of value, the main subject of our essay.

The following is key because we can understand then how this might apply to the ipoker networks:

Before we do that, however, let us note that these kinds of transaction costs, while first studied in the context of markets, are not confined to markets or even market-embedded institutions. They occur any time a good is transferred or a service rendered according to a set of rules or customs, however simple or complicated. Not only do these transaction costs provide a basis for comparing non-market or extra-market institutions such as the firm to the market; they also apply to a wide variety of other institutions, including many we may not typically think of as economic institutions

Rake: The Tax Collector’s Problem

From the point of view of many taxpayers this is an incredible claim, given that tax collectors take money we ourselves know how to spend quite well, thank you, and often spend it on amazingly wasteful activities. And the rules by which they take it often seem quite arbitrary.

There are often common missconceptions about rake.  What is rakes relationship to effective rake?  What is the ideal rake for profitability and sustainiblity of the game?  What is ideal rake for players (zero obviously?)? What is ideal rake for sites?

Of course, they have the advantage of coercion, but they must overcome measurement problems that are often the same as other users of accounting systems, such as owners of large companies. It is not surprising, then, that tax collectors have sometimes pioneered value measurement techniques, and often have been the first to bring them into large scale use.

It is seemingly sites that are bestowed with the ability to conjure up and implement different rake and rakeback schemes.  What systems might the players or the free markets create?

This is an application of the Laffer curve to the fortunes of specific industries. On this curve, developed by the brilliant economist Arthur Laffer, as the tax rate increases, the amount of revenue increases, but at an increasingly slower rate than the tax rate, due to increased avoidance, evasion, and most of all disincentive to engage in the taxed activity. At a certain rate due to these reasons tax revenues are optimized. Hiking the tax rate beyond the Laffer optimum results in lower rather than higher revenues for the government. Ironically, the Laffer curve was used by advocates for lower taxes, even though it is a theory of tax collection optimum to government revenue, not a theory of tax collection optimal to social welfare or individual preference satisfaction.

It IS in fact common economic knowledge that raising the taxes too high does in fact cause “evasion”. In terms of poker we see this as the theory that players will eventually “exit” from the site based on an equilibrium between the exit costs (remember 3 from above) and the effective rake. Szabo points out, “On a larger scale, the Laffer curve may be the most important economic law of political history. Adams[2] uses it to explain the rise and fall of empires.” and indeed we will use it to prescribe the rise and fall of poker site empires:

Governments that overburdened their taxpayers, such as the Soviet Union and later Roman Empire, ended up on the dust-heap of history, while governments that collected below the optimum were often conquered by their better-funded neighbors. Democratic governments may maintain high tax revenues over historical time by more peaceful means than conquering underfunded states. They are the first states in history with tax revenues so high relative to external threats that they have the luxury of spending most of the money in non-military areas. Their tax regimes have operated closer to the Laffer optimum than those of most previous kinds of governments. (Alternatively, this luxury may be made possible by the efficiency of nuclear weapons in deterring attack rather than the increased incentives of democracies to optimize to tax collection).

It does seem that that conditions and settings of rake and effective are in fact improtant and not as trivial and most players seem to believe.  Szabo goes on to explain, “When we apply the Laffer curve to examining the relative impact of tax rules on various industries, we conclude that the desire to optimize tax revenues causes tax collectors to want to accurately measure the income or wealth being taxed.” This is something we have alluded to before in Ideal Poker:

But of course, also, poker sites of a state cannot actually do anything of the form that can be called “rake targeting” without having some means for measuring rake. How would they do this? The means for measuring inflation that they would naturally use would be a “deposits raked” index relating to domestic transactions within the territory of the state.

From Ideal Poker, “Here the key viewpoint is methodological, as we see it.” and so it seems as a collective we should be discussing the concept of the Laffer curve in relation to the overall economy of poker:

The Laffer curve and measurement costs can also be used to analyze the relative benefits of various tax collection schemes to government.

I cannot be irrelevant to point out that the current economic climate of the game has a dramatic effect on the overall evolution of it:

 Most taxes were on the prices of commodities sold, or on various ad-hoc measures of wealth such as the frontage of one’s house. (This measurement game resulted in the very tall and deep but narrow houses that can still be found in some European cities such as Amsterdam. The stairs are so narrow that even normal furniture has to be hauled up to the upper story and then through a window with a small crane, itself a common feature on these houses).

Are we skilled readers?  Do we expect high uncertainty?  Should we?  What is the value of high or low uncertainty?

Skilled readers of financial statements know when to expect high uncertainty. Often they will demand further details from management about the specific investments. Providing greater detail where intangibles are involved is highly advisable, a point I return to below.

Such an innocent essay but with the possibility of an incredibly profound effect on many aspects of our society. For poker it helps players outline a problem of uncertainty they might not otherwise realize they have.  This is the first step to allowing them to accurately assess “effective” rake. This ultimately leads to the realization and explanation of asymptotically ideal poker as an extrapolation of ideal Poker.

The measurement of value is one of the most intractable problems of civilization. Brilliant and highly non-obvious solutions to this problem — from markets to money to the time-wage to cost accounting — have constituted some of the most important steps from animal to civilization. Historically, the solutions to one value measurement problem (e.g., accounting for value in a large firm) made possible other institutions as well (e.g. income tax, which must first solve the same kind of problem in order to be Laffer competitive with other kinds of taxation). Intangible asset accounting may now be the most important value measurement problem we face as we move beyond the era where tangible industrial commodities dominated the economy.
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