Kimchi Premium: A Crypto Investors Overview

What Is the Kimchi Premium?

The kimchi premium is the gap in cryptocurrency prices in South Korean exchanges compared to other exchanges located globally. The kimchi premium is predominantly seen in the price of the cryptocurrency Bitcoin (BTC).

In other words, the price of Bitcoin might be listed at a higher price on a South Korean exchange than on an exchange located in the United States or Europe. The name "kimchi premium" is a reference to the fermented cabbage dish that is a staple in Korean cuisine.

Understanding Kimchi Premium

Prices for Bitcoin can be higher in South Korea than on other international exchanges. Cryptocurrencies like Bitcoin are decentralized assets, meaning they don't trade on a central exchange, unlike equities. A stock that trades on the New York Stock Exchange (NYSE) has the same price no matter where in the U.S. it's purchased. However, cryptocurrencies can have different prices quoted across various countries and their exchanges.

Kimchi Premium Arbitrage

Some investors attempt to earn a profit by trading the price differences that exist on different exchanges—a process called arbitrage. Arbitrage is often associated with currency traders who look for mismatches in exchange rates when identifying arbitrage opportunities.

When a trader engages in currency arbitrage, they place trades based on differences in the quotes for a specific currency pair offered by different brokers, rather than placing trades based on the exchange rate movement of the currency pair. If executed perfectly, this kind of trade can be risk-free since the trader is buying and selling two or more currencies simultaneously, making sure there is no open currency exposure.

Arbitrage opportunities are often short-lived because as soon investors (or their trading algorithms) identify the pricing mismatch, they place enough trades to make the arbitrage opportunity no longer profitable.

The arbitrage opportunity that can result from the kimchi premium might be exploited by buying bitcoins on an exchange outside South Korea and then selling the position on a South Korean exchange where Bitcoin's price is higher. However, South Korean traders, would first have to exchange their local currency (Korean won) for another currency, such as U.S. dollars, to purchase bitcoins on an international cryptocurrency exchange. From there, they could sell their bitcoins on a South Korean exchange for a higher price. The process for foreign investors is somewhat easier since they can purchase bitcoins abroad and sell their holdings on a South Korean exchange.

History of Kimchi Premium

The kimchi premium in the cryptocurrency market first appeared in 2016, according to a report by the University of Calgary. The findings show that between early 2016 to early 2018, the kimchi premium averaged nearly 4.80% and was as high as nearly 55% in January 2018.

South Korea has become a popular market for cryptocurrencies including Bitcoin trading. The popularity could be due to the country’s interest in technology, as well as gambling, which may have led to open-mindedness and early adoption of digital currencies.

Also leading to the popularity of cryptos is the potential security issues or threats that South Koreans face from North Korea and its leader Kim Jong-un. Bitcoin and cryptocurrencies tend to be favored in countries or regions of the world that face political uncertainty and geopolitical risks. The appeal centers around the decentralized nature of cryptos, meaning they're not owned or controlled by a government entity.

The popularity of Bitcoin has led, in part, to price premiums for the cryptocurrency in South Korea when compared to the price in other countries. A rise in the kimchi premium can be an indicator of increased retail investment in Bitcoin by Korean investors.

Capital Controls and Kimchi Premium

The kimchi premium could be eliminated by South Korean investors if they were able to quickly take advantage of the arbitrage opportunity. South Korean investors could buy bitcoins outside of the country on international exchanges and subsequently, sell those positions on local, South Korean exchanges. The result would be a lower price for Bitcoin in South Korea and an increased price on international exchanges leading to an elimination of the arbitrage opportunity.

However, capital controls, financial regulations, and anti-money laundering laws in South Korea make the process difficult. Capital controls are measures taken by central banks and regulatory agencies of governments to restrict the flow of capital—or money—in and out of a country. If a significant amount of capital flees a country due to a geopolitical event or economic upheaval, the result can be devastating to the local economy.  

Foreign investors may not want to hold their money in a country that's going through a challenging period. As foreign investors sell their holdings within that country, the result can lead to depressed real estate prices, a selloff in equity and bond markets, and exacerbate the economic conditions within the country. Capital controls are often put in place to prevent money from leaving the economy in an effort to prevent a massive selloff in domestic assets.

Capital Controls of South Korea

The government of South Korea implemented capital controls in 2010 stemming from the global financial crisis and the European debt crisis. The measures were designed to reduce the wild fluctuations or volatility in capital flows that may hurt the economy.

The result is a time delay when sending money internationally due to additional administrative burdens. The amount of money that can move out of the country each year is capped, and the transfer must be approved by regulators.

Even if regulators approved the transfer, the process may take so much time that the arbitrage opportunity is no longer available. Capital controls also limit the inflow of cryptocurrencies by foreign investors, which has created a scenario in which South Koreans can only use digital currencies in their country.

Impact on Cryptocurrency Trading

South Koreans and South Korean firms are limited in their international purchases of Bitcoin. If a South Korean trader decided to exchange their currency for a foreign currency in order to purchase a bitcoin on a foreign exchange, the amount of the transaction would likely be capped or could be blocked altogether by regulators if there is suspicion of money laundering.

The impact of South Korean regulation on cryptocurrency trading, as well as the threats of a cryptocurrency ban in China, may have led to the massive sell-off of Bitcoin in January 2018 in which Bitcoin lost nearly 25% of its value in one week. Prices of Bitcoin and other cryptocurrencies plummeted as South Korea's government signaled that it planned to crack down on cryptocurrency trading. At that time, South Korea was the third-biggest market in the world for bitcoin trades behind Japan and the United States.

It's important to note that determining the volume of Bitcoin trading can be difficult considering that there is no centralized exchange that measures cryptocurrency trading volume. Although the South Korean government has threatened a complete ban, they have also considered alternatives to a complete ban, such as having investors pay capital gains taxes. They may also require investors to register investment accounts in their own names to combat money laundering. 

Example of Kimchi Premium

In January 2021, the kimchi premium resurfaced in which Bitcoin prices hit two-year highs on South Korean exchanges. It's estimated that the Bitcoin kimchi premium was approximately 4% in South Korea when comparing South Korea's Upbit exchange and Binance.

By timing a trade precisely, traders could have profited by 4% from the difference in Bitcoin prices by purchasing bitcoins on Binance and selling their position on South Korea's Upbit exchange. It was also reported by Cryptoquant that the price gap between Korean exchanges and international exchanges was more than 6% on January 4th, 2021.