South Korea’s Kimchi Premium, Alluring Arbitrage, and Competition
South Korea’s recent Act on the Protection of Virtual Asset Users has created a stir among local cryptocurrency exchanges, driven by two key provisions that have reshaped the crypto market landscape.
One regulation mandates that crypto operators maintain client funds in distinct bank accounts, while another requires the accumulation of interest on fiat deposits held by clients.
Distinct from other countries that rely solely on exchange-based KYC verification, South Korea demands direct identification of the account holder. This approach not only involves tax obligations on all income but also mandates the accumulation of interest on deposits, thereby seamlessly integrating crypto platforms with the conventional banking system.
Battle Over Deposit Rates
South Korea’s major crypto exchanges have begun vigorously competing for clients by increasing the interest rates on deposits.
Note that in this scenario, the interest rate on a deposit represents the earnings accrued from managing the clients' funds, which stay in South Korean won in bank accounts and are not converted to virtual assets. These deposits, similar to those held by securities companies, are considered temporary holdings in accounts for future investments in financial instruments.
As of June 2024, the banking deposits of South Korea's major cryptocurrency exchanges were notably large: Upbit at $4.5 billion, Bithumb at $1.1 billion, and Coinone at $81.2 million
Following the enforcement of the new Act on the Protection of Virtual Asset Users on July 19, 2024, these deposits saw a substantial increase. This was because the exchanges were no longer allowed to hold fiat funds in their own accounts, necessitating the transfer of these funds to bank-managed accounts. Moreover, crypto exchange operators were given the authority to set their own client deposit interest rates. This flexibility became a powerful tool in the intense competition for both attracting new clients and retaining the funds of existing ones, prompting exchanges to readily increase their deposit offers.
Within the first week of the law's implementation, the interest rate on some exchanges surged from 1.5% to 3.4%, suggesting that crypto deposits might become more appealing than traditional bank deposits.
*To put it in perspective, the average yearly interest rate for fiat deposits in South Korean banks is approximately 2%.
These high interest rates have significantly spurred interest in virtual assets and attracted new investors. They have also encouraged the development of new services and products within the blockchain industry. Furthermore, exchanges must continually innovate to keep their clients, who are likely comparing the competitive interest rates.
Meanwhile, traditional banks, caught up in these developments, have opted to observe the ongoing competition rather than directly participate. South Korean journalists note that while banks are keen on partnerships with crypto exchanges, they do not intend to compete for traditional monetary deposits. Bank representatives believe their positions are secure, supported by robust insurance companies and a significantly larger base of loyal customers.
However, a significant shift of South Korean funds from traditional deposits to the virtual asset sector might be on the horizon.
The Kimchi Premium and New Arbitrage Opportunities
South Korea's recent cryptocurrency market regulation has unexpectedly opened doors for arbitrage, particularly due to the kimchi premium.
This term is inspired by the traditional Korean dish and refers to the phenomenon where cryptocurrency prices on South Korean exchanges are significantly higher than on international platforms. This price discrepancy stems from strong local demand and restricted access for South Koreans to foreign exchanges. Additionally, from July 19, a new regulation prevents foreigners from trading cryptocurrencies in Korea, adding another layer to the market dynamics.
A notable instance of exploiting the kimchi premium involved the AVAIL token, which was newly listed on the South Korean exchange Bithumb.
Immediately after its listing, the token's price skyrocketed, creating a substantial price gap with its valuation on other global platforms—for instance, 3500 Korean won on Bithumb versus just 200 won at the same time on Huobi, which is registered in the Seychelles.
An unidentified trader took advantage of this situation by:
- Buying 1.2 million AVAIL tokens from foreign investors an hour before they were listed, through an announcement on X.
- Transferring these tokens to Bithumb as soon as trading commenced.
- Selling the tokens at the peak of the local trading frenzy, netting a profit of $760,000.
This trader managed to profit from the price differential across different platforms without incurring any risk.
This example, though not isolated, underscores significant challenges brought about by the new regulations.
The high interest rates foster an unusual demand spike, and the combination of the kimchi premium and the foreign trading ban opens avenues for illicit trading activities involving foreign token owners.
Officials from South Korean platforms suggest that the country might turn into a speculative crypto hub under these conditions, which could pose risks of money laundering, price distortions, and a breeding ground for market manipulations.
It's become evident since the enactment of the new law that local regulators struggle to prevent South Korean traders from acquiring cryptocurrencies from foreigners, circumventing official exchanges. By barring foreigners from trading on local platforms, the South Korean government inadvertently fosters conditions ripe for potential exploitation.
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