Bitcoin Microstructure and 
the Kimchi PremiumKJ Choi Alfred Lehar Ryan Stauffer

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Kimchi premium

▪ Bitcoin frequently trade at a higher price in Korea, a phenomenon referred to as the Kimchi Premium

On average 4.73% more expensive in Korea than the US with a maximum observed of 54.48% (Jan 2016 – Feb 2018)

▪ In frictionless financial markets such a price difference should be quickly arbitraged away • Buy bitcoin in US, for USD • Transfer to Korean exchange • Sell for KRW • Convert to USD and transfer back to US

▪ Frictions here are generated by exchanges, capital controls, and the Bitcoin microstructure itself

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Kimchi Premium Over Time

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Bitcoin microstructure

▪ Transaction verification on the Bitcoin blockchain will take ~1 hour in the best case. Up to 10 minutes to be included in the next block, plus 5 more blocks as confirmation.

▪ The transaction inclusion on the next block depends on the fee offered to miners. — Daily median confirmation time (inclusion on a block):

11 minutes average for our sample; as high as 47 min

➢Endogeneity between confirmation time, transaction fee, and volume

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Bitcoin exchange/microstructure frictions

▪ Exchange vs private wallets — When trading on an exchange, BTC are held on blockchain in wallet of exchange — Transfer of BTC: must request move from exchange account to private wallet — No data on processing times available, no regulation

▪ anecdotal evidence suggests waits can be very long

▪ Transfer of funds — Many exchanges find it hard to connect to payment systems — Credit card companies refuse payments — Banks do not process payments — e.g. Quadriga, number 2 exchange in Canada, uses a Portuguese bank

▪ Price risk during Arbitrage — US exchange -> private wallet -> Korean exchange — Price might change, posing risk for arbitrageur

▪ Fees directly reduce arbitrage profits

▪ Volatility: fluctuations in bitcoin price expose arbitrageurs to more risk during the trade

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Capital controls in Korea

▪ Limits to the amount of money than can be sent abroad —USD 3000 per transfer, with a max of USD 50,000 per year

—Credit card transactions max USD 10,000 outside Korea p.a.; this transaction is also considered a commodity purchase so customs must be paid on it.

▪ Ambiguous laws make it unclear if cryptocurrency transfers from a Korean exchange elsewhere are capital in/out-flow or commodity export/import

▪ Threats from the government to ban/restrict/regulate cryptocurrency trading

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Arbitrage attempts

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KRW bitcoin premium

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EUR Bitcoin Premium

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EUR bitcoin premium

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Comparison EUR and KRW

▪ In both markets the same microstructure frictions drive price deviations —Higher volatility and higher fees coincide with higher premia

▪ Effects are 10 times larger in Korea

▪ We argue this is due to capital controls

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Bitcoin premia and financial freedom
2017-03-01 to 2018-02-28

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Financial freedom

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▪ Economic Freedom Ranking (EFR): Fraser Institute ▪ 42 distinct variables ▪ size of government ▪ legal system and security of property rights ▪ sound money ▪ freedom to trade internationally ▪ regulation

▪ Index on capital controls (CCI) by Fernández, Klein, Rebucci, Schindler, and Uribe (2015) (IMF)

▪ Collect in great detail capital controls for a variety of financial instruments

▪ We use the sub-index on restrictions of outflows of money market instruments

▪ Use Germany as proxy for EUR area

Financial freedom and bitcoin premium

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Economic magnitude - EFR

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▪ Move from the median (Turkey, score 6.83) to the 75th percentile (Peru, score 7.47):

reduction in bitcoin premium by 1.4%

▪ Move from 75th percentile to top (Hong Kong, score 8.95): reduction in bitcoin premium by 3.2%

Complete arbitrage with other cryptos?

Korea premiums in other cryptocurrencies

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Upbit Bithumb Coinone Korbit Gopax

KRW/USD exchange rate

Similar premia in other cryptocurrencies

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Premia are highly correlated across cryptocurrencies

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Conclusion

▪ Many countries including Korea pay a premium to purchase Bitcoin

▪ Microstructure frictions — Allow prices to deviate across exchanges — Price deviations are larger when arbitrage is more:

▪ Risky: delay, volatility ▪ Costly: fees

▪ Capital controls — Amplify existing frictions in arbitrage trading — Allow BTC to trade at a high premium

▪ Greater financial freedom is associated with lower premia

▪ Similar findings across other cryptocurrencies

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