The biggest wager for popular fixed-odds betting terminals (FOBTs), which allow gamblers to bet every 20 seconds, will be cut sharply from the current level of £100, the department for digital, culture, media and sport said in a statement.
The move sent share prices of bookmakers tumbling, but was hailed by campaigners who branded the machines a "scourge on high streets".
William Hill said that half of its retail revenues came from FOBTs and that 900 of its shops could make losses and face closure as a result of the rule change.
Changes to the stake will be through secondary legislation and remain subject to parliamentary approval, while the government said it will also engage with the gambling industry to ensure operators are given enough time to implement and complete the technological changes.
A man gambles on a fixed odds betting terminal inside a Bookmakers in Manchester, Britain.
"Consolidation within our sector continues and I would also not want to see the impact of a disproportionate triennial outcome being a factor in the name of William Hill being added to the list of companies now in foreign ownership", he said.
The government wants to reduce the potential for large losses on FOBT machines and the risk of harm to both the player and wider communities.
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As part of the next licence competition the age limit for playing National Lottery games will be reviewed, to take into accounts developments in the market and the risk of harm to young people.
Now gamblers can bet, and lose, £100 every 20 seconds meaning potentially thousands of pounds in a single session.
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Each generates an average of £50,000 a year for bookmakers.
Sports Minister Tracey Crouch said that a high number of people seeking treatment for addiction say FOBTs are "their main form of gambling".
The decision to cut the stake to #2 goes further than the recommendations of a review carried out by the gambling regulator earlier this year, which recommended the maximum stake for FOBTs should be set at or below #30.
However, the announcement was widely welcomed by charities, the church and opposition politicians.
She said: "Following analysis of the evidence received at consultation, £2 has been found to be the stake limit that would most substantially impact on harm by reducing the ability to suffer high session losses, while also targeting the greatest proportion of problem gamblers, and mitigating risk for the most vulnerable players for whom even moderate losses might be harmful".
Ms Crouch added: "Problem gambling can devastate individuals' lives, families and communities".
'It is right that we take decisive action now to ensure a responsible gambling industry that protects the most vulnerable in our society.
Shares in all three companies fell in early trading on Thursday, with William Hill, down almost 3 percent at one stage, hit hardest.
Fellow gaming group 888 Holdings dropped 6 per cent, with GVC Holdings off 4 per cent and Playtech 2 per cent lower.