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Let’s say you want to bet on a horse race. Originally, bookmakers would offer fixed-odds betting: the bookmaker would assess the odds of each horse winning, and offer a payout based on that.

The problem for the bookmaker is that if he gets the odds wrong, he can be out a lot of money. Let’s say Horse #3 is a longshot and he puts the payout at 20:1, but Horse #3 is actually a much better runner than the bookmaker realized. Lots of people will bet on Horse #3 and the bookmaker will wind up paying out more money than he takes in.

Parimutuel betting solves that by essentially having the gamblers bet against each other. Basically, the odds are calculated based on what bets are placed. To make the math simple, suppose we have 4 horses racing and the bets are as follows:

Horse 1: $125

Horse 2: $300

Horse 3: $350

Horse 4: $225

The total amount wagered was $1000. And let’s say the house takes 10% of the bets for itself, so there’s now $900 to award to the winner. So we look at who won — let’s say it was Horse 2. There’s $900 to divide among $300 worth of bets, so for every dollar you bet on Horse 2, you win $3.

The key is you don’t know the payout until betting closes. Bookmakers will provide approximations, and those get updated as betters continue to place bets up to post time, but the actual payout isn’t known until betting closes.