What is The Kimchi Premium?

Bitcoin is a decentralized cryptocurrency. It flows across borders, and it’s difficult for governments to stop its spread or shut it down. But what governments and central banks can do is restrict how their citizens spend fiat currencies, including how said money enters and leaves the country, and how it’s used to buy Bitcoin.

In South Korea, capital control and anti-money laundering laws on the won, South Korea’s currency, have spiked the price of Bitcoin within the country since 2016. That’s because it’s difficult to turn the won back into the U.S. dollar, which dissuades international arbitrageurs from exploiting the price gap.

Because traders on South Korean exchanges struggle to move money in and out of the dollar, the delays create a backlog of demand, temporarily boosting the price of Bitcoin. The phenomenon has been endearingly termed the “Kimchi Premium” after the country’s dish of pickled cabbage and radish.

A 2019 paper from the University of Calgary found that the Kimchi Premium first occurred in 2016. The researchers found that between January 2016 and February 2018, South Korean Bitcoin exchanges charged an average of 4.73% more than their U.S. counterparts, and in January 2018, Bitcoin was as much as 54.48% more expensive in South Korea.

When it’s in play, the Kimchi Premium is bad for South Koreans who pay more for their Bitcoin, but good for arbitrageurs who buy low elsewhere and sell high on Korean Bitcoin exchanges.

“Traders could buy Bitcoin in another market, say the US, then transfer them to a Korean Bitcoin exchange, sell them for Korean won, and convert the won to US dollars for an instant profit,” wrote the researchers.

Sam Bankman-Fried, the former CEO of the former crypto exchange FTX, reportedly moved $25 million a day by moving money through Japan to make the most of a similar arbitrage opportunity.

The Kimchi Premium has persisted since the publication of the paper. In April 2021, when Bitcoin soared to a new all-time high, the Kimchi Premium was as high as 22%, according to data from CryptoQuant.

What is Bitcoin?

For those that are unsure what Bitcoin is, let alone the Kimchi Premium, here’s a brief primer to keep you in the loop.

Bitcoin is a decentralized cryptocurrency that runs on a distributed database called a blockchain. Unlike regular cash, which is minted and controlled by a central bank, Bitcoin is entirely virtual and controlled by an autonomous network of computers run by anonymous entities around the world. You can help the Bitcoin network by “mining” it with powerful computers and earn Bitcoin as a reward for doing so.

The cryptocurrency was created in 2008 by a pseudonymous developer called Satoshi Nakomoto. His invention spawned an entire economy of cryptocurrencies and decentralized financial applications; several thousand cryptocurrencies trade on purpose-built exchanges. Combined, cryptocurrencies have a market cap of about $2.3 trillion, as of October 2021.

Although discussions about the Kimchi Premium generally revolve around Bitcoin, the cryptocurrency with by far the largest market cap, the researchers found that “other cryptocurrencies have practically identical premia to Bitcoin at Korean exchanges and those premia are highly correlated over time with the Kimchi premium.”

South Korea isn’t the only country where cryptocurrencies such as Bitcoin have been quoted at higher prices than elsewhere. Japan and Nigeria are among countries that have recorded large premiums. Small price discrepancies exist among exchanges in liquid markets, such as North America. Currency arbitrages exist in traditional forex markets.

The Kimchi Premium isn’t constant. When South Korean traders dump their Bitcoin during bear markets, the lack of demand often creates a negative premium—in other words, when South Koreans aren’t interested in Bitcoin, you might be able to buy the cryptocurrency for a discount in the country.

Why does the Kimchi Premium exist?

The Calgary research paper concludes that the main reason why South Korea’s premium has persisted for so many years isn’t that arbitrageurs are irrational, but because tight capital controls make it difficult to profit from the Kimchi premium. “If it were easy, it would have been arbed already,” Doo Wan Nam, who heads Asian business development for Maker, told Decrypt.

South Korea implemented stringent capital controls in 2010 following the global financial crisis of 2008 and subsequent debt crises in Europe. The rules were designed to prevent foreigners from using the won in short-term foreign debt, which had caused problems in Europe.

“These measures are aimed at reducing the volatility in capital flows that poses a systemic risk in the country,” South Korea’s central bank, finance ministry, and financial regulators said in a joint statement in 2010.

The restrictions limited how banks and financial institutions swapped in and out of currencies. In 2017, just before the Kimchi Premium hit its peak, Koreans could only send up to $3,000 per transfer and up to $20,000 a year through a single financial institution.

That made buying Bitcoin tricky; the U.S. dollar is by far the most traded cryptocurrency for Bitcoin, and its status as the world’s de facto reserve currency means that foreign traders often have easy access to it.

It was also difficult for foreigners to set up accounts with crypto exchanges: They needed a South Korean bank account and cell number, something you couldn’t acquire if you were a foreigner visiting South Korea to take advantage of the arbitrage. “It is almost impossible to obtain them by just temporarily visiting South Korea,” wrote the Calgary researchers.

Plus, South Korea’s financial regulator hadn’t yet determined whether Bitcoin was a “financial currency” or a “good.” If it’s the former, importers must first declare it to a South Korean bank. If it’s the latter, it must be reported to customs agencies. This gray area dissuaded foreigners from messing around in South Korea’s Bitcoin market, concluded the Calgary researchers.

All this means that, unlike in other markets, forex arbitrageurs and trading bots can’t easily close the gap and the market can’t resolve the arbitrage. Jonathan Leong, founder of Taiwanese crypto exchange BTSE, told crypto news site Decrypt that the Korean won is “a restricted currency, which limits the ability for easy currency conversion and cross-border transfer. Without the conversion path, the arbitrage loop cannot be closed by arbitrageurs.”

Additional restrictions on crypto might explain why the difference has persisted for so many years. In April 2021, a major Korean exchange prevented withdrawals of the won on new accounts, and four days earlier several South Korean banks had stopped money transfers to international crypto-related entities. When that happened, the premium shot up to about 18%.

In addition, lots of small exchanges shut down in September 2021 when the government introduced additional money-laundering restrictions, which small exchanges struggled to implement.

The largest cryptocurrency exchange in South Korea, by far, is Upbit, followed by Bithumb, Coinone, and Korbit. Combined, these exchanges account for more than 90% of all crypto trading in the country, according to the Financial Times. These exchanges have all taken steps to comply with money laundering laws.

The government also wants to crack down on scams. Regulators say that reports of crypto fraud increased by 42% in 2020, and state authorities accused Bithumb and Coinbit of fraud; former Coinbit employees told Coindesk that several employees face fraud charges for bolstering trading volumes by creating fake accounts.

In 2022, the government will introduce a capital gains tax on crypto, which will force anyone profiting more than $2,135 to pay taxes of 20% on their crypto gains.

South Korea’s Bitcoin market

The Kimchi Premium could have been especially apparent in South Korea because there’s a lot of demand for Bitcoin. A survey from job portal Samarin found that a third of all workers owned Bitcoin in 2017, and even in September 2021, the Financial Times found that 5.49% of all fiat currency trades for Bitcoin used the South Korean won, making it the third most popular fiat currency for Bitcoin trading after the US dollar and the euro.

Indeed, several newspapers have attributed the attraction of South Koreans to crypto with the large number of unemployed youth, who invest in Bitcoin with the hopes of becoming rich. Data released in August 2021 by Yoon Doo-hyeon, a member of the South Korean government’s Political Affairs Committee, found that about 60% of new crypto investors in South Korea are in their 20s and 30s.

High internet speeds, a strong gaming industry, rising house prices and a familiarity with micropayments could also explain Bitcoin’s popularity with South Koreans. “Especially during bull markets, the kimchi premium tends to happen as South Korean retail speculators FOMO into the markets,” Vetle Lunde, an analyst at Arcane Research, told Decrypt.

The Kimchi Premium has had one other effect: There are some cryptocurrencies that trade almost exclusively within South Korea. These coins, known as Kimchi Coins, are generally issued by South Koreans. They have small market caps and low liquidity. Lots of these tokens have been delisted from major exchanges, such as Upbit, as South Korean exchanges step in line with fresh regulation.