Children are being groomed for gambling through hugely popular multiplayer first-person shooter games such as Counter-Strike:Global Offensive and Dota2 but their parents are oblivious, Senator Xenophon told Fairfax Media.

"This is the Wild West of online gambling that is actually targeting kids," Senator Xenophon said.

The "insidious" games played by hundreds of thousands of Australian teenagers "purport to be one thing" but are "morphing into full-on gambling and that itself is incredibly misleading and deceptive", he said.

"Instead of shooting avatars, parents soon find out that [their children] have shot huge holes through their bank accounts," Senator Xenophon said.

Gambling on competitive video games – eSports – is estimated to be worth $US8 billion ($10.5 billion) this year. It is growing exponentially worldwide but is almost wholly unregulated. The relevant Australian legislation, the Interactive Gambling Act 2001, is "15 years old but may as well be 150 years old in terms of dealing with these issues", Senator Xenophon said.

Legislation could make it illegal for games to seek payment for items of varying value according to chance, as is the case in Japan. There could be minimum age requirements on paying to play, and games could be required to carry clear warnings of gambling content,

The bill for which he is likely to seek bipartisan support will define gambling in a way "that includes these sorts of games", he said.

Gambling is encouraged both within games and on third-party websites. In Counter-Strike, one of the world's most lucrative game franchises, players can pay $US2.49 to obtain "skins" or gun decorations from "cases" provided within the game by Valve, the game's developer. Images of the possible items within a case flash across the screen as if in a slot machine. The item gained can be worth as little as a few cents (common) or as much as a few thousand dollars (extremely rare).

These skins can then be sold for credit on Steam, Valve's game marketplace. They can also be bought and sold on third-party sites, which use Steam accounts to transfer skins.

Skins are used as betting currency on dozens of sites offering casino-style chance games or bets on competitive games. It is estimated the $US7.4 billion to be wagered on skin gambling this year may balloon to $19.3 billion within four years, although a recent crackdown on third-party gambling sites will likely curb growth.

Cash betting on eSports is also exploding. European online betting company Bwin says punters will plunge more on League of Legends, a multiplayer online battle arena video game, than on the real-life European Champions League football this year for the first time. Cash betting on eSports is estimated to be worth $600 million this year but $13.6 billion by 2020 as eSports matches grow in popularity on mainstream broadcast networks.

The scale of eSports gambling in Australia is unclear but it is believed to be widespread. As a clue, 9000 people placed skin bets on a Counter-Strike match involving Sydney teams that 3000 people watched live on Thursday night. The match was equivalent in profile to a weekly NRL match.

Under existing law, it is illegal for companies not registered in Australia to allow people in Australia to bet on their sites. In practice, the Australian Federal Police are not prosecuting, says Anna Thomas, senior research fellow with the Australian Gambling Research Centre. The warp speed growth and convergence of online gambling and gaming makes it "really difficult for legislators to keep up", Dr Thomas warns.

Sally Gainsbury, senior lecturer at Southern Cross University's Centre for Gambling Education and Research, says it is "very concerning" that people who have had no previous interest in betting are "all of a sudden exposed to gambling" in video games, then migrate to gambling sites.

Research involving 2000 Australian adults indicates those who have paid money into games (it is now common to buy items or progress to a higher level) are "more than twice as likely to go on to gambling as a result".

"In the absence of regulation, we really need to have [education] that these sites are not safe to use, these are illegal sites and are not regulated in Australia and there is no protection," Dr Gainsbury said.

A 25-year-old Sydney man with the username "sayNo" said he started out by "investing" $400 in Counter-Strike skins. Betting "$50 here, $100 there" on CSGO Lotto, he eventually cashed out winnings of $2000 using a PayPal account. His betting account peaked at $15,000 before he lost all of it.

He said he did not bet "in real life" but "I got up to that big mark where I thought I was winning all the time and I could not stop".

"It is appealing because, ultimately, you want to have the better skin," sayNo said. "It's very enticing."

ESports gambling has been the subject of intense recent controversy after revelations in the United States that famous gamers known as "streamers" either secretly owned or were being secretly paid to promote betting sites to the online audiences of millions who tune in to watch them play video games.

It emerged that at least one famous streamer was being told the outcomes of gambling games in advance so he could win more often to provide better "entertainment" for his viewers.

In another case, it was revealed two of the biggest streamer names – Trevor "TmarTn" Martin and Thomas "ProSyndicate" Cassell – failed to disclose they owned the CSGO Lotto gambling site they had been promoting to their combined audience of 10 million.

After Counter-Strike developer Valve was named in two lawsuits, one brought by an anonymous Florida mother who said her son had lost "significant" amounts of money gambling on video games, the company sent cease and desist letters first to 23 gambling sites and this weekend to a further 20 warning their commercial use of its platform was contrary to its terms and conditions.

The sites included CSGO Lounge, CSGO Diamonds, CSGO Wild and CSGO Lotto. Many but not all of those targeted have since stopped operating.