Bitcoin microstructure and the Kimchi premium

Between January 2016 and February 2018, Bitcoin were in Korea on average 4.73% more expensive than in the United States, a fact commonly referred to as the Kimchi premium. We argue that capital controls create frictions as well as amplify existing frictions from the microstructure of the Bitcoin network that limit the ability of arbitrageurs to take advantage of persistent price differences. Using data from leading crypto-exchanges, the bitcoin blockchain, and on international FX-rates we find that the Bitcoin premia are positively related to transaction costs, confirmation time in the blockchain, and to Bitcoin price volatility in line with the idea that the delay and the associated price risk during the transaction period make trades less attractive for risk averse arbitrageurs and hence allow prices to diverge.

We document that the same microstructure frictions correlate with price differences between European and US markets but the effect is about ten times stronger for Korea, which we attribute to the capital controls. Arbitrageurs cannot circumvent capital regulations by using other crypto-currencies because premia for other cryptos such as Litecoin, Ether, and Ripple are of similar magnitude and they are highly correlated with the Bitcoin premium. A cross country comparison shows that Bitcoin tend to trade at higher prices in countries with lower financial freedom. Finally unlike the prediction from the stock bubble literature, the Kimchi premium is negatively related to the trading volume, which also suggests that the Bitcoin microstructure is important to understand the Kimchi premium. Despite the aspiration by many crypto-currency enthusiasts to create currencies free from government influence we show that government restrictions for fiat currencies have important pricing implications for unregulated financial instruments such as Bitcoin.