The Kimchi Premium Explained A Crypto Market Phenomenon

What is Kimchi Premium? The heat of the Korean cryptocurrency market is hot. However, due to government regulations and high demand, the prices of Korean cryptocurrency exchanges are higher than those of other overseas exchanges. This phenomenon, called “kimchi premium”, derived from the traditional Korean food kimchi, has already become a notable feature in the cryptocurrency world.

Where does Kimchi Premium come from?
The kimchi premium is mainly driven by Korea’s restrictive capital controls, i.e. regulations that limit capital inflows and outflows. These regulations are usually adopted in emerging markets to manage the level and influence of foreign investment, and in the case of Korea, capital controls have been tightened since 2010 to ensure the country’s economic stability after the 2008 financial crisis.

These controls make it long and difficult for exchanges to move large amounts of global decentralized cryptocurrencies such as Bitcoin into the country. As it becomes difficult for Korean residents to buy cryptocurrencies on overseas exchanges, Korean exchanges have been able to sell relatively limited amounts of cryptocurrencies at a higher price. This kimchi premium phenomenon first appeared around 2016 and has since become a notable feature of the cryptocurrency market.

Why does the kimchi premium continue?

In general, in a global context, the difference in asset prices between markets becomes almost equal over time. So, what is the reason that Kimchi Premium is still showing strength five years after it first appeared? This appears to be due to several situational factors.

Kimchi Premium and Bitcoin Arbitrage

Some enterprising traders are making profits through kimchi premium arbitrage by taking advantage of the price difference of specific assets in each market. Such arbitrage often serves to address market inefficiencies and price differentials.

In the case of Kimchi Premium, arbitrage is made by purchasing bitcoins, etc. from overseas exchanges, not domestic exchanges, and selling them in Korea to make a profit. But it’s not as simple as it looks. Korean traders who trade in this way must convert their domestic currency to another foreign currency in order to purchase cryptocurrencies. This process takes a certain amount of time, which is relatively risky due to the volatility of crypto assets, and rapid price fluctuations can make arbitrage efforts unsuccessful.

In addition, due to capital control policies that prevent the inflow of short-term speculative capital in order to protect the domestic economy mentioned above, currency exchange may subject Korean traders to taxation, annual limits on international transactions, and other costs.

How does Kimchi Premium affect foreign traders?

Korean traders aren’t the only ones struggling with this ‘kimchi premium arbitrage’. Korean cryptocurrency exchanges require each user to provide a Korean phone number and bank account, as it is relatively difficult for foreign traders to obtain a Korean phone number and account. However, arbitrage trading can be very advantageous for foreigners residing in Korea. The Korean government recently announced that overseas remittances to China have increased eightfold, and there are speculations that Chinese traders are making profits through cryptocurrency arbitrage while living in Korea. These issues have become the focus of further governmental regulatory discussions on the flow of cryptocurrencies.

Another disadvantage of kimchi premium arbitrage is that it may involve commissions during the transaction, which may reduce profits. When a blockchain like Bitcoin is in high demand, traders often have to pay higher transaction fees to process transactions on time.

In time-sensitive arbitrage strategies, these costs can be unavoidable. Some researchers argue that all these factors are related to the Korean government’s control of the capital, making it difficult to close the price gap. Because Koreans have such restrictions on access to overseas exchanges, a general arbitrage strategy cannot be very effective. This is why the kimchi premium continues.

Why is Kimchi premium emerging as a major issue in the global cryptocurrency market?

A high kimchi premium means enthusiasm for cryptocurrency demand and the peak of the cryptocurrency market cycle. The size of the kimchi premium has changed significantly over time. In 2016 and 2018, Bitcoin was, on average, 4.73% more expensive in South Korea than in the US, but sometimes the difference was as much as 63%.

The kimchi premium tends to peak when global demand for Bitcoin and other cryptocurrencies reaches all-time highs. In fact, there are cases where the global cryptocurrency market was affected by the Kimchi premium in 2017-2018 and the upcoming Korean government regulations.

South Korea announced plans to crack down on crypto trading in January 2018, weeks after Bitcoin peaked at close to $20,000 in December 2017. This led to an immediate crash in the market. And other regulatory news from the U.S. and China sparked fear again, with Bitcoin losing more than half its value in two weeks and continuing to fall in the months that followed.

Reverse Kimchi Premium

In a bear market, the kimchi premium is much less pronounced and could even lead to a situation where cryptocurrencies are cheaper in Korea compared to the global market.

In the current cryptocurrency bull market, the Kimchi premium is showing a full-fledged recovery, reaching up to 18%. However, some argue that the kimchi premium is not showing the same market dynamics as in 2017-18 due to a number of rapidly changing factors. This includes broad interest and investment in cryptocurrencies by Koreans of all ages as a countermeasure against inflation. However, as Korea is one of the largest cryptocurrency markets, it is still significant as a general indicator of cryptocurrency demand.

What will happen to Kimchi Premium in the future?

Overall, it seems that the kimchi premium will continue at this point, but overall cryptocurrency trading in Korea is facing a headwind. Recently tightened regulations on crypto trading and anti-money laundering laws further restrict the operation of exchanges. Domestic cryptocurrency exchanges are now required to register as virtual asset service providers, work with banks, strengthen anti-money laundering, and follow Know Your Customer (KYC) policies.

The deadline to comply with these requirements is September 2021, and so far, there are no exchanges that comply with these regulations in Korea. However, the Chairman of the Financial Services Commission recently announced that about 200 cryptocurrency exchanges operating in Korea could be shut down in September 2021 if they do not comply.

This influence is expected to affect the further adoption of domestic cryptocurrencies. Considering the size of the domestic virtual currency market and regulations proposed in 2017, the crackdown on exchanges may also affect global virtual currency prices.

Next month it will be revealed whether these exchanges are compliant with government regulations. Among the many regulations, contract regulations with domestic commercial banks seem to be feasible only in a few large domestic exchanges.

It is also true that this is a burden for small companies, as banks partially charge a fee for the authentication system in this process. Some have even criticized these measures, making the cryptocurrency market dependent on the approval of the traditional banking system. They say this will hinder the decentralized operation of the blockchain and may lead to conflicts of interest between banks.

Meeting all the requirements of these new regulations will take time and effort, and virtually few exchanges seem to be able to file reports by the September deadline without making significant changes to their operations. While some exchanges can handle without problems, many others (especially smaller ones) seem unavoidable from the blow of the new regulations. The concentration of cryptocurrency flows through a small number of exchanges could exacerbate the kimchi premium problem if cryptocurrency demand remains high.

Anyway, Kimchi Premium is likely to continue as long as the cryptocurrency boom continues, exchanges continue to operate, and strict regulations in Korea are maintained. However, significant changes in any of these factors could have a greater impact on the global cryptocurrency market, along with a decline in the kimchi premium.

Summary

The Kimchi Premium may or may not accurately predict the craze or speculation in the global crypto market, but generally gives a rough indication of the demand for cryptocurrencies. Currently, there is a lot of demand for cryptocurrencies, but it is unclear how the government’s continued efforts to regulate crypto flows will have an impact. If the government and cryptocurrency exchanges do not reach a compromise by September, the exchange may close and the kimchi premium may turn into a ‘kimchi apocalypse’, which can seriously adversely affect free trading in the domestic as well as global cryptocurrency markets.

Cryptocurrency proponents today dream of decentralized finance. However, the kimchi premium shows that governments still have a large influence on the cryptocurrency market, suggesting that cryptocurrency growth and adoption will depend on national policy frameworks. As a result, as the evolution of cryptocurrency continues, more and more changes are expected in the cryptocurrency market in the future.