The argument that arbitrage presents a risky way for cryptocurrency investors with the view of making a profit cannot be disputed. However, this does not explain risk arbitrage. At the end of it all, each one poses a threat to making an investor lose money. Though they share this similarity, it does not make them one and the same, really.
While arbitrage mainly focuses on investors taking advantage of the difference in the price of bitcoins, for instance, across separate financial markets with a view to making a profit, risk arbitrage concerns itself with investing in a share following the announcement of a corporate takeover deal. The differences in both investment strategies are better seen using the following indices:
1. Reason for Buying: Typical arbitrage does not focus on a particular share. The aim of an investor that trades in bitcoins is to take advantage of a difference in its price across financial markets and nothing more. This is not so with risk arbitrage where the focus of an investor lies on the market prices of shares with respect to both the company that has an intention to buy another, known as the Acquirer and the firm they want to acquire, called the target, before the consummation of a takeover.
2. Profit-Making: All that interests a cryptocurrency investor, in the case of arbitrage, is to make a profit from the difference in price of bitcoins based on how it fares in different markets. In most cases, the bitcoins are bought and sold in real-time. Risk arbitrage, on the other hand, is based on the assumption that an Acquirer will eventually own the target firm. In simple terms, it is all about "Mergers and Acquisitions." The aim of an acquirer is to narrow the gap at which the target firm's share is priced and the valuation price they place on such shares, thereby, allowing investors an opportunity to make a profit.
3. Available Buying Options: There is only one option open to a cryptocurrency investor who deals on arbitrage - cash. This means that they need to buy the bitcoins, for instance, before selling for a profit. Though there are different strategies to this from Simple Arbitrage to Triangular Arbitrage and Convergence Arbitrage, it still involves paying for the bitcoins with cash. Acquirers are not limited to making cash payments alone. They are spoiled by the additional options to either offer a stock-for-stock payment or combine cash payment with a stock-for-stock offer.
4. Risk: There is no guarantee that price will remain the same when an investor buys bitcoins in a market where it is undervalued before returning to sell them in a market where it was previously overvalued. In the case of short-selling, there is also no guarantee that the price will move in the direction expected by an investor. These are the kinds of risks faced in pure arbitrage. For risk arbitrage, it is all about the consummation of a takeover deal. Once a market regulator prevents an intended takeover deal from taking place, an investor loses money for investing long in the target firm's shares and short in that of an acquirer.
Although the term "arbitrage" remains common between both kinds of investment strategies, risk arbitrage is undertaken by investors following the announcement of a possible merger and acquisition.