Slippage in crypto refers to the difference in price between the time you place a trade and the time it executes. It often results in a higher price than you intended. On decentralized exchanges, you can tweak the settings to set the maximum slippage you are willing to accept. In this article, I will walk you through all you need to know about crypto slippage.
Table of Contents
- A Primer on DEXs
- Why Is it Called Slippage?
- How to Control Slippage
- What Is a Good Slippage?
- What Do You Mean by Liquidity?
- Positive vs. Negative Slippage
- Slippage on Centralized Exchanges
- Slippage by Order Type
- Are Slippage and Spread the Same Thing?
- How Does Crypto Slippage Occur in the Market?
- Types of Crypto Slippage
- Strategies to Minimize Crypto Slippage
- FAQs
First, you need to understand how a slippage on a Decentralized Exchange works.
A Primer on DEXs
Decentralized exchanges such as Uniswap, PancakeSwap, THORChain and so on all operate based on smart contracts.
Smart what?
A smart contract allows you to write rules to automate the app or protocol you build on top of a blockchain.
For example, you might code up an app called Smartie that sets the following rule:
“If someone sends 1 BTC to xyz address then mint and send her 100 new Smartie tokens”.
Yes, you can do stuff like that in crypto.
And then the app can just exist and follow that rule forever.
This is why the term “decentralized” is used.
There is no need for a central intermediary to intervene for a decentralized finance (DeFi) app to work.
Amazing.
Back to DEXs
DEXs follow a specific formula when you trade.
If you want to swap 1 BTC with 1 ETH how does the DEX know how much ETH to give you?
Well, it turns out DEXs use a formula.
For example, Uniswap follows this formula
x*y=k
where
- x is the amount of BTC available on the DEX
- y is the amount of ETH available on the DEX.
- the total value of BTC equals the total value of ETH
- k is the resulting number
What is special about K is that it has to stay constant after anyone places a trade.
Let’s take a look at an example:
At the time of writing 1 BTC=$27,000 and 1 ETH=$1,600
Let’s say that the DEX has 1,000 BTC.
The DEX will have an equal amount of ETH in value on it.
So then it will have 27,000*1,000/1,600=16,875 ETH in it.
Let’s plug these numbers into the formula to find k
k=16,875 ETH * 1,000BTC=16,875,000
OK great. Now imagine you come along and want to trade 1 BTC for some ETH.
How much ETH do you get?
Ideally, you should get somewhere close to $27,000/$1600=16.875 ETH
Let’s see what Uniswap will give you.
Remember, k needs to be constant so we get:
[new amount of BTC] * [New amount of ETH] = k
When you trade BTC for ETH you are giving the DEX your BTC.
Hence the new amount of BTC = 1000+1
So
[1,000 +1] * [New amount of ETH] = 16,875,000
Hence
[New amount of ETH] = 16,875,000/1,001=16,858.1419
So the amount of ETH you will get is
[Old amount of ETH – New amount of ETH]=
16,875-16858.1419=16.8581 ETH
after which you will need to deduct 0.3% in fees to the exchange.
Not too bad.
In reality, Uniswap has way more volume in their liquidity pools so k will be much larger and your exchange of 1 BTC will equal the going rate precisely.
Here is what the formula looks like on a graph
Example of High Slippage
Now let’s do another experiment
Let’s trade 300 BTC. What rate will you get then?
Let’s plug it into the formula again.
We need:
1300 BTC * [new amount of ETH]=16,875,000
Hence:
New Amount of ETH = 16,875,000/1300=12980.7692
So you will get
16,875-12980.7692=3,894.2308 ETH
which implies a price of
300*27000/3894.2308=2080
Woah! What happened here? The actual price of ETH was $1,600 but you got it at $2,080. Your trade was so large relative to the total amount of BTC that it moved the price.
Why Is it Called Slippage?
The closer you are to the middle area on the x*y=k curve the closer the price will be to the going market rate. However, if you trade a large amount your trade will move the price i.e. it will slip along the curve at an exponentially worse rate.
If you really want to get to grips with how decentralized exchanges work I recommend you study my tutorial about Uniswap.
How to Control Slippage
You saw how if you place a large market order compared to the total supply of a trading pair the price slips a lot.
But the price always slips.
It might slip infinitesimally but it always slips.
The cool thing with DEXs is that you can define the maximum slippage you are willing to accept by adjusting slippage tolerance.
This way you can ensure a better price.
What Is a Good Slippage?
In general, for markets with high liquidity a slippage of 0.3-0.5% is considered good.
You might find however that with less liquid assets where there are fewer crypto traders you need to accept a higher slippage.
For example, if you want to buy a new meme coin that is only just getting traction there might not be enough sellers and liquidity for it.
In this case, your order might move the price significantly and you may need to increase your slippage tolerance closer to 1% or more.
What Do You Mean by Liquidity?
Liquidity on a DEX is the amount, in value, of the trading pair that you want to trade.
These pairs are placed in what is called a liquidity pool.
Anyone can provide liquidity.
For example, you could go to Uniswap and give them 50% in value in BTC and 50% in ETH to join their BTC – ETH liquidity pool.
In return for doing you receive trading fees.
Positive vs. Negative Slippage
- Positive slippage occurs when the executed price is better than the expected price. It can happen when there is a sudden spike in demand or a decrease in supply, leading to favorable trading conditions. However, positive slippage is relatively rare and often associated with limited trading volumes or illiquid crypto assets.
- On the other hand, negative slippage occurs when the executed price is worse than expected. This type of slippage is more common, especially during high crypto market volatility or when trading large volumes. Negative slippage can result in higher transaction costs and reduced profitability for traders.
Slippage on Centralized Exchanges
Slippage is not unique to DEXs.
The price can change between the time you place the trade and it is executed on centralized crypto exchanges as well.
In fact, the term is common in mainstream financial markets and likely originates from the stock market.
What is unique about DEXs is that you can set your price slippage tolerance.
Slippage by Order Type
On centralized exchanges, slippage can also be influenced by the type of order a trader places.
- Market orders, which are executed at the best available price, are more susceptible to slippage compared to limit orders.
- Limit orders allow traders to set a specific limit price at which they are willing to buy or sell a cryptocurrency, reducing the chances of slippage.
Are Slippage and Spread the Same Thing?
No, slippage results from market volatility whereas the bid-ask spread is the difference between what the buyer is willing to pay (bid) and what the seller is asking for (ask).
A centralized exchange will take this spread as fees.
How Does Crypto Slippage Occur in the Market?
The following can cause crypto slippage:
#1. Lack of liquidity
Liquidity refers to the ease with which an asset can be bought or sold without causing substantial price movement. Digital assets with low trading volumes or illiquid markets are more prone to slippage.
#2. Volatile Markets
During periods of high volatility, prices can change rapidly, making it challenging to execute trades at the intended price. This is especially true for cryptocurrency traders who rely on market orders, which prioritize execution speed over price precision.
#3. Order Book Depth
The order book represents the current buy and sell orders in the cryptocurrency market. If there is a limited number of orders at a specific price level, executing a large volume trade can lead to significant slippage as the market depth is insufficient to absorb the trade.
#4. Network Congestion
When the network is congested, transactions may take longer to confirm, resulting in delays in executing trades. This delay can lead to price fluctuations during the transaction process, causing slippage.
#5. Trading Strategy
Traders who use aggressive trading strategies, such as high-frequency trading, may experience higher levels of slippage compared to those who use more conservative strategies. This is because aggressive strategies often involve frequent and rapid trading, which can increase the likelihood of encountering slippage.
Types of Crypto Slippage
Here are the different types of slippage that you may encounter as a trader:
- Instantaneous Slippage: This type of slippage occurs when a trade is executed at a different price from the expected price almost instantly. It is commonly seen during highly volatile market conditions where prices change rapidly.
- Delayed Slippage: Delayed slippage occurs when an order takes longer than expected to execute, leading to a difference between the intended price and the executed price. This can happen when there is low liquidity or network congestion, causing delays in order processing.
- Gap Slippage: Gap slippage occurs when there is a significant price gap between the expected execution price and the price at which the order is eventually executed. This type of slippage is often observed during market openings or after news announcements that cause price gaps.
- Partial Fill Slippage: Partial fill slippage happens when only a portion of the order is executed at the intended price, while the remaining volume is filled at a different price. This can occur when there is insufficient liquidity to complete the entire order at the desired price level.
- Latency Slippage: Latency slippage occurs when there is a delay in the transmission of trading orders, resulting in a difference between the intended execution price and the actual executed price. This can happen due to network latency or technical issues with the trading platform.
Strategies to Minimize Crypto Slippage
While slippage is inevitable in some cases, here are some strategies to try to minimize it:
- Limit Orders and slippage tolerance. If you are trading on a centralized exchange you are better off by placing a limit order. If using a DEX then you can adjust your slippage tolerance.
- Monitor Order Books: Keeping a close eye on the order book depth to be sure that the market is liquid.
- Break Up Large Orders: Instead of placing a single large order, break it up into smaller orders. If you execute smaller orders you will reduce the price impact and increase the likelihood of getting your intended price.
FAQs
What is an example of slippage in crypto?
Say the market price of ETH is $1,600. But in the time between when you press the buy button and the trade is executed you buy it at $1,632. Your slippage is the price difference of $32 or 2%.
Is higher slippage better?
No, a higher slippage means that you bought the asset at a higher price that the specific price at the time you placed the market order. In general you want to avoid very high slippage because you might end up overpaying for an asset.
What is a good slippage tolerance in crypto?
Usually 0.3-0.5% is a good slippage tolerance. For more illiquid assets such as new tokens you could bump your slippage tolerance up to 1% if you are willing to pay that much more. As a rule you can tolerate a higher slippage if you plan to hold the asset for a long time in the expectation that the price of the asset will rise considerably. Otherwise, if you are frequent trader you should avoid slippage in excess of 0.5%.
Is slippage bad in crypto?
In general you want to minimize negative slippage as much as possible. However, you are never going to 100% eliminate it. On rare occasions you might have positive slippage which results in you buying the asset at a lower price than what you expected.
Can you avoid slippage?
You can't completely avoid as even the tiniest of trades will have some infinitesimal slippage. But you can follow strategies to minimize slippage such as adjusting your slippage tolerance, using limit orders and avoiding illiquid trading pairs.
Does slippage make you lose money?
Yes technically slippage causes you to lose money because it usually means that you purchase the asset at a higher price than what the market price was prior to the trade. In liquid markets slippage percentages are very low though. On rare occasions price swings in the market can result in positive slippage in which case you pay less for the asset.
What is negative slippage?
Negative slippage is the most common type and occurs when you buy an asset at a higher price that what the market price was when you placed the order.
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