Not so long ago, one of the original investors in internet betting exchange, Betfair, was surprised to hear that the modest sum he had put into the project five years ago had multiplied by a figure somewhere north of 20.

Its founder, Andrew Black, wasn't so much surprised by the multiple as by the fact that Betfair was still in business at all. Not only is it very much in business, it has a 90 per cent market share and makes real profits. In fact, it has turned out to be one of the few successful (or for that matter, useful) internet plays launched during the dotcom boom.

A combined experience of bookmakers and the New York Stock Exchange (NYSE) gave Black the original idea for Betfair. It's not hard to see why. At first glance, there's probably not much difference between trading floors and racetrack betting rings.

Both involve risk and the exchange of large amounts of cash; one party is offering something, the other is buying it; and everybody is shouting at each other in jargon.

But Black spotted the key difference between the two during a "not very successful" stint as a trader with the NYSE. Nobody sets prices on the exchange's trading floor - everybody bids and offers against everybody else. Conversely, in a betting ring, the bookies set the prices or odds, and the punters take them or leave them. The same thing applies to high street bookmakers and their websites and phone lines.

Black, a keen punter since he backed his first winner as a child at Goodwood in England, set out to combine the two in Betfair. The concept is simple: subscribers to the site bet against each other.

Like a bookie, they can offer, or lay, odds against a particular horse winning a race. Somebody else can accept those odds and bet on them in the manner of a conventional punter. Or they can do a combination of both.

So, for example, if you don't fancy Best Mate to win the Cheltenham Gold Cup in two weeks' time, you can go on to the site and offer odds against him. Currently he can be backed at around five to two (2.5 to one) with most bookmakers. You will have to offer better odds to attract bets. Thus you could have to go as high as 2.75 to one or possibly three to one.

At the same time, if you do fancy him, you can go on to the site and back him at better odds than are available on the high street. Or you can back and lay any combination of horses in the race, even while they are running.

As long as someone else is willing to lay or back it, you can have whatever bet, or combination of bets, you want, across a whole range of sports. Betfair simply matches people who want to lay and those who want to bet.

The combination of good odds and allowing punters to play both sides of a proposition is a central attraction. Also, unlike a bookmaker, Betfair needs people to win in order to make money, as its revenues come from taking a commission of between 2 per cent and 5 per cent of an individual's profit.

Black believes the model is vastly superior to that offered by the bookmakers, whose odds he believes are literally stacked against the punter.

"I mean, you've got massive margins there," he says. "You have to be convinced, because you're playing at such a big 'over-round', it's very, very difficult to make money."

The over-round is the bookmaker's guaranteed margin on a given race or event. They achieve this by offering odds on a given horse that are actually lower than its true chance. For example, if a runner's real chance is five to one, they will offer 4.5 to one. Depending on the event, the over-round can deliver a guaranteed profit of anything from 7 per cent to 20 per cent.

So it is true, the bookies never lose. But nor does Betfair. In 2004, it had pretax profits of €19 million from revenues of €97 million. At the end of the year, shareholders' funds stood at a healthy €44 million. Around 5 per cent of this was drawn from Irish punters, who account for 15,000 of its total subscriber base of 300,000. It employs 450 people, including a small staff in Dublin.

However, like the bemused investor who discovered that he had backed an internet winner, few people believed it would actually work.

Black began the project when he was working as a computer programmer at the British Government Communications HQ, part of its intelligence service, which is based, appropriately enough, in Cheltenham.

For security reasons, workers were sent home at 5pm, which gave him the time to begin working on Betfair. However, it was not until he hooked up with his brother's friend, Edward Wray, that it began to become a reality.

Wray worked in the City of London, and was looking for a change. He sat down and did the business plan while Black worked on the nuts and bolts of the site. The pair began to visit venture capitalists. But, while the VCs were busily firing other people's cash into the internet maw, they turned down Betfair.

A key problem was flutter. com, an internet betting site, that Black says was more a billboard than an exchange. But it had mopped up whatever the money men were willing to put into online betting. (Betfair has since swallowed it up.)

So Black and Wray turned to the latter's network of well-paid friends and ex-colleagues from the financial world. "It was at the height of the dotcom thing, and people were making crazy bonuses," Black recalls. "They had all this money and they wanted it to work for them, so they gave some of it to us." By getting €50,000 here and €100,000 there, they raised €1.5 million and launched in mid-2000.

But its career has been controversial in some respects. Because people can lay horses, it's been connected with allegations of corruption in racing. The logic is simple: someone connected with a horse can lay it, ensure that it does not win, and collect.

To combat this, Betfair has signed a memorandum of understanding (MOU) with English racing's regulator, the Jockey Club, that allows officials to investigate betting patterns on the exchange in suspected cases of corruption.

Publicly, both parties maintain that this is working, and Betfair has co-operated with one ongoing investigation in the UK.

It is negotiating an MOU with the Irish racing authorities, and has signed other MOUs with the governing bodies of other sports that attract betting (even cricket). Nonetheless, conventional bookmakers have been saying "I told you so". Nor surprisingly, Black dismisses this.

"If our system of open outcry, working in partnership with the regulator, was the accepted model, and they (the bookmakers) came along and said 'we'll fix the prices and we won't share information with anyone', then everybody else would say 'you've got to be having a laugh'," he argues.

Like most people who know racing, he points out that it is not as corrupt as people assume. And where it is, it's at the lower levels of the sport, simply because there's too much at stake at the top. And the highest level of national hunt racing is very much on punters' minds, as the starter's tape goes up on the Cheltenham Festival in just 11 days.

Black expects three times the normal level of business on Betfair during the four-day extravaganza. However, he himself does not have quite the same sense of anticipation as he had before Betfair, largely because it is now so closely associated with work.

He maintains his interest in horses through ownership. He is a partner in a syndicate called the Comic Strip Heroes. One of its horses, Captain Hurricane, is entered in the English 2,000 Guineas at Newmarket next May. You can probably back it on Betfair at a price that will give an even greater return than an investment in the exchange.