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Bitcoin bucks ‘law of one price’ to regulators’ dismay

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TOKYO — The vastly different price of digital currencies between countries and exchanges has led investors to seek out arbitrage opportunities with greater zeal, a trend that has caught the eye of financial watchdogs around the world.

The price of bitcoin in South Korea is relatively high compared to other markets, a gap known as the “kimchi premium.” When the price of bitcoin soared in January, 1 bitcoin was worth about 2 million yen in Japan but the equivalent of about 2.6 million yen in South Korea. That’s a premium of 30%, though the kimchi premium has reached as high as 50% at times.

“At first, I couldn’t believe that its value would jump as much as 10% just by sending it” to another country, said a South Korean man in his 20s who works in Japan. He became engrossed by bitcoin in May 2017 when he repaid a friend from home about 500,000 yen ($4,500) in bitcoin because the remittance fees are cheap. The price of bitcoin in won was 10% higher than in yen.

Digital currencies are traded in many countries with varying prices in each one. The value of bitcoin in Zimbabwe, for example, is currently 80% higher than in Japan. Hyperinflation has made bitcoin popular there since many do not trust the home currency.

It is natural for price differences to emerge in international transactions. Someone buying foreign currency in yen before the Japanese currency weakens, for example, will pocket a profit.

Digital currencies like bitcoin, however, are financial products that defy the law of a universal price. An even trickier problem is that variations emerge not only across borders but also within them as slight differences emerge between exchanges.

Traders exploit such disparities in price to lock in profits, a practice known as arbitrage.

The South Korean and his friend developed an automated trading program that made a profit of several hundred thousand yen the first month. The pair raised 100 million yen from investors and launched a crypto asset management company in January. Their operations center around nine exchanges in Japan and South Korea, and carry fees of about 10% per month.

“The advantage of arbitrage trading is that it is hardly impacted by market fluctuations, but prices may converge if many people keep an eye on them,” the man said.

Even so, prices differences remain. The value of bitcoin across six Japanese digital currency exchanges, including bitFlyer and Bitbank, varied by as much as 1,600 yen in May.

On stock markets, for instance, investors cannot employ arbitrage because every stock has only one price at any given time.

“Institutional investors do not trade bitcoin due to concerns about cyberattacks,” said Naoyuki Iwashita, a finance professor at Kyoto University. “This makes it more difficult to offset price differentials with large trades, unlike with currencies and stocks,” he said, adding that it shows a lack of trust in digital currencies.

Bank of Japan Gov. Haruhiko Kuroda said that “cryptocurrencies aren’t legal tenders and don’t have assets to back up their value” and that “their use for remittances and payments is small.”

A research group launched in the spring by Japan’s Financial Services Agency has also been critical of digital currencies, citing the ability to speculate with large amounts of leverage. The watchdog also said the market is risky since fluctuations in price are largely divorced from the real economy. The Federal Reserve Bank of New York has also taken issue with distorted prices. Given such concerns, Japanese financial regulators are debating restrictions on leverage and other regulation.

Crypotcurrency investment has swollen to about 70 trillion yen and some 3.6 million traders annually, mainly retail investors. Despite the popularity, the currencies are not ready for use in financial transactions given the wide variations in price, even within a single country.

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