Dwaine van Vuuren has identified an important reason why local cryptocurrency exchanges in South Africa sell the likes of Bitcoin for prices higher than the global average. South Africa currently has two prominent Bitcoin exchanges, Luno and ICE3X. Van Vureen, in this piece then, unpacks why prices on LUNO are much higher than the global average owing to the arbitrage phenomenon(‘arb’ for short). As van Vuuren outlines, arbitrage gives incentives to sellers of crypto in a small market like South Africa to make higher-than-average returns. The high arbitrage also ties into South Africa’s stricter exchange controls.
“Buyers of Bitcoin on Luno have to purchase from local sellers on Luno and vice versa,” he said.
“The global supply of Bitcoin is limited, with only 1,800 new Bitcoin minted per day. When the local demand outstrips local supply, the local price has to rise to coax holders to part with their Bitcoin.”
As a result, the local price of Bitcoin in ZAR can trade up to a 35% premium to the global dollar average taken from all major exchanges, he said.
In an interview with MyBroadband in June, Luno’s Werner van Rooyen said that the main driver of the local Bitcoin price was the South African market, not the exchange.
“Although it is easy to speculate about the causes for the Bitcoin premium seen from time to time, it is important to realise that you are not trading directly with Luno,” said van Rooyen.
“We merely provide the platform on which buyers and sellers interact. The forces of supply and demand ultimately determine the price,” he said.
This price deviation between local and foreign exchanges is called an arbitrage.
“This high arbitrage phenomenon is prevalent in many emerging economies with limited choice of high-liquidity Bitcoin exchanges, stricter exchange controls or where access to international bank accounts is limited,” said van Vuuren
“Since the local supply is restricted, the arbitrage is much more sensitive to, or reflective of investor euphoria – which makes arbitrage a great measure of sentiment.”
However, this also opens up some opportunities to make money, van Vuuren said, where one can buy the cheap Bitcoin in dollars offshore and sell them on Luno for a higher price and guaranteed profit.
“We normally pencil in at least 5% ‘friction’ on the trade to cover slippage, transaction costs etc, which means arbitration needs to be at least above 10% to make it worthwhile,” van Vuuren said.
The Future of Bitcoin in South Africa
While it is possible to make money from this arbitrage, van Vuuren said the price discrepancies are more useful in how they reflect market sentiment.
“The higher the arbitrage, the higher the local South African bullish sentiment. Conversely, the lower the arbitrage, the higher the bearish sentiment,” he said.
“More recently, the arbitrage expanded to 14% (we saw 17% intraday) and Bitcoin put in a top almost immediately thereafter. The lesson here is the same as with stock market assets. Buy assets when they are cheap.”
“It does not make sense buying Bitcoin at a 15-20% premium to global prices.”