Bitcoin ATM Liquidity Providers

In this post we look at how operators can organize supply of bitcoin ATMs with liquidity. For simplicity purpose only buy bitcoin transactions (sell bitcoins to customers) are considered.

When running a bitcoin machine every operator needs to provide it with liquidity. Usually this is done via using own capital (fiat and BTC) in order to fund hot wallet (from where bitcoins are sent to customers) or additionally holding some liquidity on bitcoin exchange (fiat currency liquidity), which is converted to BTC when transaction happens to lock exchange rate and laterto replenish hot wallet for future transactions. You can read more details about it in Running bitcoin ATM from own hot wallet or Operating bitcoin ATM via exchange.

Disclaimer: This post is written based on Q&A email correspondence with Cumberland mining from October 2016. Every operator has to do their own due diligence on counterparties, as there is still counterparty risk present.

Operating a bitcoin ATM using own liquidity (hot-wallet or bitcoin exchange)

So to recap, what are two general ways of operating a bitcoin ATM:

  1. Running a machine from own hot wallet. Operator purchases bitcoins in bulk and deposits them to hot wallet which is connected to ATM. Whenever, customer purchases bitcoins — machine gets cash and initiates outgoing BTC transaction  to customer’s address. Periodically operator collects cash from bitcoin machine and purchases bitcoin in bulk again to replenish hot wallet for future transactions.

Pros:

  • Almost no counterpary risk. The advantage of this scheme is there is literally no risk of funds loss due to other contracting party failure (unless for the short conversion period, but depends on what is the way of conversion is used). This absence of risk is a result of full control over funds by operator during the whole period of operation.

Cons:

  • Exchange-rate risk. While purchase of bitcoins (to replenish hot wallet) and actual transactions happen at different time — there is a high probability that BTC exchange rate changes over time. So operator has to absorb this risk. It doesn’t necessary mean a loss, so in case a price of bitcoin increases — operator actually gets additional gain because of BTC appreciation, however, there is a risk of price going down, which will result in potential loss.

 

  1. Another way of operating a bitcoin machine is usually via having some relatively small BTC liquidity in hot wallet (1-2 day volume) and the rest of liquidity is hold in fiat currency at a bitcoin exchange. In case transaction happens funds are sent to customer from operator’s hot wallet immediately, however, at the same time conversion of fiat currency to BTC happens at an exchange in order to lock rate and guarantee the fee size that operator charges, periodically once a day or after every transaction, BTC funds are withdrawn to hot wallet for replenishment.

Pros:

  • Almost no exchange risk. In case mirror transaction happens immediately and there is no large price slippery on the exchange, operator generally replenishes BTC at the same price he sold, so the fee size charged on top of price is guaranteed. In case bitcoin price falls, only hot wallet balance is affected, while the fiat currency stored at exchange is not impacted.

Cons:

  • Counterparty risk. This scheme requires to hold funds balance at exchange permanently. Which means operator doesn’t fully control funds, in case exchange has difficulties, like relatively recent hack of Bitfinex and further overall hair-cut of 36% will mean operators who hold funds at this exchange lost 36% of funds.

Operating bitcoin machine via liquidity provider

This scenario is illustrated on the following diagram (click to enlarge):

Operating bitcoin ATM via liquidity provider

The way it works is similar to the scenario 2 above (via exchange), while instead of bitcoin exchange the role of converting fiat currency to bitcoins is fulfilled by bitcoin liquidity provider. Here is how it works:

  1. When transaction happens (T1) (customer buys bitcoins at ATM) funds are sent from hot wallet of operator (so there should be own BTC liquidity provided by operator). At the same time (T1) instead of doing a mirror transaction at an exchange (like in #2 scheme) pure information is sent to liquidity provider, who locks the rate for this particular amount. Important is the fact that at this moment no actual transfer of funds or exchange happens, only agreement to lock the price. Over time such deals accumulate and at some moment (T5) operator wires funds to liquidity provider, who converts funds based on all individual rates happened over time and sends BTC funds to wallet of operator facilitating further transactions (T6).

Pros:

  • Reduced counterparty risk compared to bitcoin exchange. Advantage here is that operator is not required to hold funds with liquidity provider. Transfer of funds happens periodically and fiat currency is immediately converted by liquidity provider upon receiving funds and BTC funds are sent to operator. There is still minor counter party risk present for the time between funds are wired (T5) and until BTC is received (T6).
  • No exchange risk. As liquidity provider effectively locks the price for each transaction time and amount, this basically guarantees the exchange rate for operator. So in this sense it is similar to option of working via bitcoin exchange.
  • No slippage in price. This might be not very critical as average bitcoin ATM transaction is in the hundreds of dollars range, however, liquidity provider allows to conduct large transactions of 100 BTC or more at guaranteed rate, while if doing this via exchange there will probably be a price slippage, and operator can lose on exchange rate.

Cons:

  • Doesn’t eliminate requirement for holding BTC liquidity. In this case the amount of BTC funds in operator’s wallet should probably be larger than in the case with exchange, as transactions for conversion are accumulated over time and then all converted in bulk at the same time. With bitcoin exchange operator can replenish hot wallet after each transaction. Normally also in bulk mode, but for smaller period of time.
  • Fits more for network operators rather than individual. Liquidity providers are targeting high volume contractors and usually there is a minimum threshold amount required for conversion.
  • Higher than exchanges conversion fees. Usually operators charge fees higher than bitcoin exchanges.

Practical example with Cumberland Mining

Lets see how it practically works. We have been in contact with Bobby Cho from Cumberland Mining (www.cumberlandmining.com) OTC liquidity provider, which is a subsidiary of trading firm DRW Trading. The company already works with a number of bitcoin ATM operators. We approached 4 largest ATM manufacturers, currently integration with Cumberland mining is provided by Genesis Coin only.

Operators can buy and sell from Cumberland mining at XBX (tradeblock’s index) +- fee %. Generally these fees are less than 1%. Rates provided are fixed and executable 24/7. So say if rate set for operator to buy bitcoins at XBX + 0.7%, when customer buys bitcoins from operator, information about amount is sent to Cumberland mining and particular amount at this rate is reserved for future settlement.

This liquidity provider has a minimum settlement threshold of $25’000, which means operator needs to accumulate transactions for this volume in order to be able to convert it to BTC. If operator runs one machine this amount can be collected over about a month period, however, when there is a network of bitcoin ATMs the cycle can be reduced to weekly settlements or just once in several days. That is why in the cons it is mentioned that this service fits more for large operators. Generally, for US customers settlement happens on the same day when wire was sent, so time gap between T5 and T6 is very small.

The process of entering this agreement is like any other business agreement, operator needs to provide required documents about company, business, shareholders etc. After due diligence process on Cumberland mining side, a trading contract is sent. After signing it operator is provided with access to tradeblock account where API keys can be generated and used further for integration with machines.

Conclusion

Operating bitcoin ATM via liquidity providers gives additional benefits to operators compared to existing schemes of fully operating from own funds — reduces counterparty risk, while still eliminating exchange risk effectively. Disadvantages of this option are that it doesn’t fit all operators, mostly large ones, and rate is higher than commission at exchanges.

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