April 12, 2024

South Korea’s kimchi bounty in the spotlight after BTC’s record highs

A bowl of kimchi, a side dish of fermented vegetables that is a staple of all Korean meals

Kitzhoek | Getty Images

You may have heard of the “Korea discount” in the South Korean stock markets. Now get ready for the ‘kimchi premium’, named after the popular side dish of fermented vegetables that is a staple of Korean cuisine.

The ‘kimchi premium’ refers to the price difference in cryptocurrencies, especially bitcoin, when listed in South Korea, compared to those in US or European exchanges.

While this may be seen as an arbitrage opportunity for some, it is not that easy to make money quickly.

The kimchi premium will then be back in the spotlight bitcoin reached an all-time high in mid-March and rose past $73,000 to an all-time high on March 13, according to data from Coin Metrics. The digital currency has since fallen below the $70,000 level.

As bitcoin tested new highs, the kimchi premium also rose. According to cryptocurrency data provider Cryptoquant, on March 16, the Korea Premium Index reached its highest level since May 2021, reaching 10.88%.

That means the trading price of bitcoin in South Korea was about 10% higher than the global spot price.

In 2017, FTX founder Sam Bankman-Fried saw an arbitrage opportunity in the price gap between different exchanges. The CEO of the failed crypto exchange FTX was convicted of crypto fraud last week and sentenced to 25 years in prison.

As a quantitative trader, he noticed in 2017 that the price difference of bitcoin could sometimes be as much as 60%. The arbitrage opportunity was especially attractive in South Korea, where prices there were significantly higher than in other countries.

He then launched his own trading firm, Alameda Research, to trade the digital currency full-time, in some cases raking in $1 million a day.

In 2022, the then 30-year-old billionaire told CNBC that he was attracted to the industry because the broad arbitrage opportunities “seemed too good to be true.”

The bounty

According to research from the University of Calgary, Bitcoin often trades at a higher price in South Korea than in other markets.

Although the average kimchi premium was 4.73% between January 2016 and February 2018, it reached a level of 54.48% in January 2018, according to the report published in 2019.

Why is there a price difference?

It occurs because crypto, unlike stocks or bonds, are decentralized digital assets that use blockchain technology that is not controlled by a central authority, and can therefore be traded at different prices around the world.

One factor for the price difference is the high demand for cryptocurrencies in South Korea, in what is sometimes called “a closed market environment.”

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To prevent money laundering in crypto trading, the country’s Financial Services Commission has implemented a so-called “real name” policy, requiring that the name of an individual’s domestic virtual asset trading account matches the name on his deposit account at a bank.

Only South Korean citizens or foreigners with a resident registration card are allowed to open full-fledged bank accounts in the country, effectively barring overseas access to the domestic crypto exchanges.

“South Korea requires a specific type of bank account linked to an individual to open a crypto exchange account, making it challenging for institutional players to enter the crypto market,” said crypto data platform Chainalysis in a report from 2023.

Bitcoin prices in South Korea are above other global exchanges as demand is mainly driven by retail investors as institutional and foreign investors cannot participate freely.

Chainalysis added that South Korea received a total crypto value of over $111.82 billion between July 2022 and June 2023 – the largest amount of any East Asian country, even surpassing Japan and China, the region’s largest economies.

The report also noted that South Korea appears to be the least institutionally driven market in East Asia based on transaction sizes.

“This is likely due to local regulations that make it difficult for financial institutions to trade,” the report said.

Heavy arbitrage

The Kimchi bounty may seem like an arbitrage opportunity, but it’s not that simple.

In theory, an investor can buy bitcoin on an international exchange at a lower price, transfer the cryptocurrency to a South Korean bitcoin exchange at a higher price, and make a risk-free profit by selling it on the South Korean exchange.

However, the fact that the South Korean won is regulated, makes this arbitrage strategy difficult for international investors, explains Baik Seunghoon, country manager for South Korea at crypto mining company GoMining.

He pointed out that the won is a very limited currency and the transfer of won coins abroad is strictly controlled.

Citing South Korean capital controls, Baik pointed out that so-called “small overseas money transfer agencies” are only allowed to transfer a maximum of $10,000 per transaction for each individual, up to a total of $100,000 for the same person per year.

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This means that there is a limit to the amount of fiat money that can be withdrawn, which by extension limits the profit margin that traders can pay out.

According to research from the University of Calgary, there are also other risks associated with this arbitrage strategy.

First, transferring bitcoin from a foreign exchange to a South Korean exchange takes time, and during that time the price of bitcoin can change.

Checks by CNBC revealed that transfers can take anywhere from one hour to one day before moving cryptocurrencies to an external wallet.

This means that investors run the risk of the kimchi premium shrinking or disappearing completely during the time it takes to execute the arbitrage trade.

Paul Brody, global blockchain leader at EY, told CNBC that while the kimchi premium has been around for a while, he believes it is more difficult to execute arbitrage trading today than in the past.

“What’s different now is that in many other parts of the world it’s becoming increasingly difficult to send money over the blockchain without doing any KYC,” Brody said. He referred to the know-your-client process, which requires the identity of customers to be verified by financial institutions to reduce financial crime.

In addition, he said that exchanges that comply with regulations will limit an investor’s ability to send money abroad unless an investor has the necessary documentation and regulatory support.

In brief, the reality is that time, fees and capital controls can create complications, making capitalizing this strategy less attractive or downright infeasible.

— CNBC’s MacKenzie Sigalos and Kate Rooney contributed to this report.

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