What is Kimchi Premium
The kimchi premium is the gap in cryptocurrency prices
July. 28, 2020
What is Kimchi Premium
The kimchi premium is the gap in cryptocurrency prices in South Korean exchanges compared to foreign exchanges. The kimchi premium is predominately seen in the price of the cryptocurrency bitcoin. The name "kimchi premium" is a reference to the fermented cabbage dish that is a staple in Korean cuisine.
Understanding Kimchi Premium
Currency traders look for mismatches in exchange rates when identifying arbitrage opportunities. When a trader engages in currency arbitrage, they place trades based off of 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. This kind of trade is risk-free since the trader will buy and sell 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.
South Korea has one of the larger markets for cryptocurrencies and accounts for roughly 10% of bitcoin trading. Economists believe that interest in cryptocurrency in the country may be driven by a lack of other high-return investment options. The country’s interest in technology, as well as gambling, may also be factors.
Kimchi premium is the gap in cryptocurrency prices in South Korean exchanges compared to foreign exchanges. It is speculated that the reason for this difference in price is due to a lack of high-return investment options for investors in South Korea, the country's interest in technology and the popularity of gambling.
Investors in South Korea can only profit from the difference in cryptocurrency prices in their country versus international markets by purchasing bitcoin abroad and reselling it in South Korea. However, capital controls, financial regulation, and anti-money laundering laws make this process difficult. South Korean traders pay a higher price for bitcoins than traders in other countries. This price difference was starkly evident in December 2017, when the price of bitcoin in South Korea was more than 40% higher than prices in the United States.
In order to take advantage of arbitrage, South Korean traders would first have to exchange the Korean currency for a different currency, such as the U.S. dollar, to purchase a bitcoin on a foreign cryptocurrency exchange. The process for foreign investors is much easier; they simply have to purchase bitcoins abroad and sell them on a South Korean exchange. The draw of profit for South Koreans could eliminate this gap and the opportunity for arbitrage, but capital controls, financial regulations, and anti-money laundering laws in South Korea make the process difficult.
The amount of money that can move out of the country each year is capped, and the transfer must be approved by regulators, so South Koreans and South Korean firms are limited. If a South Korean trader decided to exchange their currency for a foreign currency in order to purchase a bitcoin on a foreign exchange, this transaction would likely be blocked by a regulator out of suspicion that it is really being made to launder money.
Even if regulators approved of 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. This has created a scenario in which South Koreans can only digital currencies in their country.
According to the cryptocurrency website CryptoCompare, more than 10% of ethereum and 5% of bitcoins are traded against the South Korean won. The impact of South Korean regulation on cryptocurrency trading, as well as the threats of a cryptocurrency ban in China, may have been a leading cause in the massive sell-off of bitcoins in January 2018.
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
On Dec 15, 2017, at the height of the bitcoin mania, the price of the cryptocurrency hit a high of $18,479 at Coinbase, a San Francisco-based cryptocurrency exchange. On the same day, the price of a bitcoin at Bithumb, an exchange in South Korea, reached a high of $21,000. By timing their trade correctly, traders could have profited as much as 14% on the difference in bitcoin prices.
To do this, they would have had to purchase bitcoin through Coinbase and sell it through Bithumb. Their profits would have been even higher a week prior when the price of bitcoin at Coinbase was $16,134.83 and it was trading for $23,880 at Bithumb.