Virtual assets are first included in the regulatory framework. How did South Korea's new cryptocurrency regulations perform in their first month?

Author: Tiger Research

Compiled by: Nan Zhi, Odaily Planet Daily

New Cryptocurrency Regulations in South Korea

Since the first ban in 2018, the South Korean government's approach to regulating virtual assets has changed significantly. Ultimately, South Korea has incorporated virtual assets into its current regulatory framework. A key moment in this transition is the enforcement of the "Virtual Asset User Protection Act" on July 19, 2024, which emphasizes a strong focus on investor protection. Note: South Korea banned any form of ICO in 2017 and considered shutting down cryptocurrency exchanges in 2018.

This regulatory shift aims to address ongoing issues of arbitrage, fraud, and illegal solicitation, which the existing anti-money laundering-focused framework has failed to adequately resolve, exposing significant regulatory gaps related to illegal rebate activities.

Specific Provisions

The "Virtual Asset User Protection Act" aims to protect domestic virtual asset investors and promote market integrity, including four key provisions:

• Clarification of the scope of crypto assets: Defines crypto assets as "an electronic representation of economic value" and excludes certain assets (such as NFTs and CBDCs) from regulation;

• Mandatory payment of interest on customer deposits: Requires cryptocurrency operators to pay interest on the Korean won deposits held by customers;

• Requirement to purchase insurance and set aside contingency funds: The law mandates the purchase of insurance and the accumulation of contingency funds to address issues such as hacking and system failures;

• Strengthened regulation of unfair trading practices: Establishes specific penalties for insider trading and market manipulation, prohibits the suspension of deposits and withdrawals without just cause, and requires cryptocurrency operators to establish systems for monitoring and reporting suspicious transactions.

These measures aim to enhance the transparency and stability of the cryptocurrency market and protect users. However, certain ambiguities remain, making it crucial to examine the market's evolution in the month following the law's enactment.

One Month After the New Regulations Took Effect

Among the four key points of the new law, the most impactful for the South Korean cryptocurrency market are the "mandatory payment of interest" and the "strengthened regulation of unfair trading practices."

High-Interest Deposits and Competition

The mandatory payment of interest income forces cryptocurrency operators to distribute interest on customer deposits to investors, which was previously a source of their income. While paying interest on stablecoin deposits is common, paying interest on fiat currency deposits is extremely rare globally, primarily due to the unique nature of capital inflows and outflows in South Korea.

In South Korea, under the "Specific Financial Information Act," trading in Korean won on exchanges requires the opening of a "real-name account" at a bank. Unlike other countries that use methods including KYC verification, South Korea requires the direct linking of real-name accounts as the only way to trade cryptocurrencies on centralized exchanges, making the payment of deposit interest unavoidable.

Shortly after the "Virtual Asset User Protection Act" took effect from July 19 to 20, the five major exchanges in South Korea engaged in fierce interest rate competition. Starting from an initially announced rate of 1%, the rate rose to 2% within a day, and Bithumb recently raised the rate to 4%. Note: As of August 20, the yield on South Korean 10-year government bonds was 2.972%, and 2-year bonds were 3.048%.

This competition may stem from past experiences with real-name accounts. At that time, market leader Bithumb chose Nonghyup Bank, a traditional bank where opening non-face-to-face accounts is relatively difficult. In contrast, Upbit opted for KBank, which allows for quick non-face-to-face account openings, leading to a shift in market share. For Bithumb, this aggressive move to set high interest rates represents a strategic intent to reclaim its leading position.

Currently, South Korea's benchmark interest rate is 3.50%, the average interest rate for regular bank deposit accounts is 2.07%, and the average interest rate for securities company CMA accounts is 3.14%. In comparison, exchanges are engaging in quite fierce competition through higher interest rates.

This competition is feasible because the financial burden has shifted to the banks associated with the exchanges, rather than the exchanges themselves. As of last year, Upbit's customer deposits amounted to $2.9 billion, and at a 0.1% interest rate provided by KBank, the estimated interest income would be around $29.2 million.

However, with the implementation of the new law and the increase in interest rates by exchanges, KBank's cost burden will significantly increase. If Upbit's interest rate rises to 2%, its interest expenses will increase nearly twentyfold. This structure allows exchanges to provide significant benefits to customers without incurring substantial costs.

Upbit's revenue in 2023 was $890 million, and although the interest income is quite considerable, it constitutes a small proportion of total revenue, so exchanges are likely to use this strategy to attract and retain customers.

Kimchi Premium and Market Manipulation

The following chart shows the price movements of certain tokens before and after their listing on South Korean exchanges, with Upbit's listing effect being particularly pronounced in recent years.

While cryptocurrencies typically experience a "kimchi premium" after being listed on South Korean exchanges, AVAIL exhibited an extremely extreme price disparity. Note: The new law took effect on the 19th, while AVAIL was listed on Bithumb on the 23rd.

The maximum price difference of AVAIL between Bithumb and Bybit reached 1,335%. A user purchased a large amount of AVAIL from overseas investors who could not access South Korean exchanges through the X platform and then sold it in bulk on Bithumb for substantial profits. Note: Based on 3,200 KRW, the highest price on Bithumb was $2.4, while the highest price on other exchanges was about $0.24.

Source: Subscan

Analysis of the transactions related to the mysterious user shows that he transferred $1.2 million worth of AVAIL through 113 addresses and recovered $2.49 million worth of AVAIL, with an average return of 2.07 times per user. The mysterious user earned approximately $760,000 in revenue through arbitrage fees.

This incident highlights several key issues related to the "Virtual Asset User Protection Act," including price manipulation, the market impact of large-scale sell-offs, and the responsibility of exchanges to monitor abnormal trading. Additionally, it raises legal questions about selling tokens on behalf of foreigners who cannot access local exchanges, which also presents potential money laundering risks.