What is the Kimchi Premium?
In the world of cryptocurrency, a premium refers to a situation where a digital currency is priced higher on one exchange than on others. This is commonly seen on South Korean exchanges and is famously known as the "Kimchi Premium."
The term "Kimchi Premium" comes from the popular Korean fermented cabbage dish, "kimchi." This premium is predominantly observed in the price of Bitcoin, where it can be sold at a higher price on a South Korean exchange than on an exchange located in the United States or Europe. The Kimchi premium is a result of capital controls in South Korea.
Interestingly, this difference in prices on different exchanges presents an opportunity for a strategy known as arbitrage. In arbitrage, traders buy a cryptocurrency at a lower price on one exchange and sell it at a higher price on another, profiting from the price difference. However, capital controls and financial regulations in South Korea make this process challenging and often not profitable. Furthermore, the South Korean government has been adamant about regulating trades on crypto exchanges to eliminate this irregularity. Despite these measures, the kimchi premium continues to exist, demonstrating the complex and dynamic nature of cryptocurrency markets.
Understanding the Kimchi Premium
Bitcoin prices 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. This means a cryptocurrency can be traded at different prices around the world.
The price difference becomes a premium when one exchange's prices are higher than another. If caught by a trader at the right moment, this opportunity is called arbitrage—buying and selling an asset on different exchanges to take advantage of price differences. When prices on one exchange are consistently higher, it becomes known for its "premium" prices. The term "kimchi" comes from the popular South Korean pickled cabbage dish of that name.
So, because bitcoin has generally traded higher on South Korean exchanges, the arbitrage opportunity became known as the kimchi premium.
Why does the Kimchi Premium exist?
A critical factor contributing to the Kimchi Premium is the strict financial regulations in South Korea. The South Korean government has enforced stringent capital control rules that limit the flow of money in and out of the country. These regulations, along with other anti-money laundering laws, make it challenging for traders to exploit the Kimchi Premium through arbitrage. Even though buying low on an international exchange and selling high on a South Korean exchange seems like an easy profit, the regulatory hurdles often make it unprofitable.
History of the 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 and early 2018, the kimchi premium averaged nearly 4.80% and nearly reached 55% in January 2018.
South Korea is a popular market for trading cryptocurrencies. The popularity could be due to the country's interest in technology and gambling, which may have led to open-mindedness and early digital currency adoption.
Also leading to the popularity of cryptos is the potential security issues or threats South Koreans face from North Korea and its leader, Kim Jong-un. Bitcoin and cryptocurrencies tend to be favored in countries or regions 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.
Bitcoin's popularity 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 indicate increased investment in bitcoin by Korean retail investors.
Kimchi Premium Arbitrage
Some investors attempt to profit by trading the price differences on different exchanges—a process called arbitrage. Arbitrage is often attempted by 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 buys and sells two or more currencies simultaneously, ensuring there is no open currency exposure.
The arbitrage opportunity that can result from the kimchi premium might be exploited by purchasing bitcoins on an exchange outside South Korea and then selling the position on a South Korean exchange where its 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.
Capital Controls and Kimchi Premium
The kimchi premium could be eliminated by South Korean investors if they could quickly take advantage of the arbitrage opportunity. South Korean investors could buy bitcoins outside the country on international exchanges and sell those positions on local exchanges. The result would be a lower price for Bitcoin in South Korea and an increased price on international exchanges. This would then eliminate 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, a massive selloff in domestic assets can devastate the local economy.
The Bottom Line
The kimchi premium is an arbitrage opportunity, where a trader could profit from buying a cryptocurrency on an exchange outside of the country for a lower price and selling in the country for a higher price. This price difference has been present for some time, but it is difficult to take advantage of it because of the controls the South Korean government has in place.
