What is price slippage in cryptocurrency trading?

Main

• Price slippage is the execution of a market order at a price that differs from the price specified in the order on the exchange.
• This phenomenon is typical for any assets, including cryptocurrencies. Most often, price slippage occurs in the field of decentralized finance (DeFi), namely decentralized exchanges (DEX).
• The reasons for slippage when trading crypto assets can be too high volatility or, conversely, insufficient liquidity. In the case of on-chain transactions, the speed of confirmation of transactions in the blockchain is of great importance.

How does price slippage occur?

When placing a market order on an exchange, the user expects the order to be executed at the specified price. However, the actual execution may differ in a disadvantageous direction – this is called price slippage. It is calculated as a percentage of the nominal value of the transaction.

The reason for slippage can be a high spread, that is, the difference between the sell and buy price of this asset, as well as the low volume of the asset in the order book.

The presence of a large number of participants, high trading activity, large volumes of assets at different price levels in the glass – all this is a guarantee of high liquidity, that is, the ability to sell or buy as many cryptocurrencies as possible at various prices. Under such conditions, the probability of experiencing price slippage in a trade is practically zero.

Why is price slippage common on decentralized cryptocurrency exchanges?

Large centralized cryptocurrency exchanges have long solved the problem of low liquidity. However, they can still have specific situations that can lead to price slippage. For example, this can happen during sharp movements in the price of the entire market or a single popular crypto asset. A strong surge in trading volume leads to the fact that the trading system will not have time to process the flow of applications on time.

A serious delay in the execution of an order is an even more significant risk for the DEX. Trading on such sites is carried out in the blockchain and completely depends on its performance: a new block must appear to execute the transaction. If the network that a trading protocol uses is slow, then its users may experience price slippage even during “quiet” periods.

In most cases, slippage has little effect on price. But when the market for a particular instrument is active, such as during a bull market, slippage becomes more noticeable.

According to DeFi Llamain DeFi, the share of productive blockchains, such as Avalanche, BNB Chain or Polygon, is growing, but almost 60% of all blocked liquidity is in Ethereum, which has a low throughput.

How is price spread related to price slippage?

The market spread is the difference that occurs between supply and demand at market prices and occurs when the market is unstable or not liquid enough.

When the user makes a purchase “at the market”, he agrees to the lowest seller’s price. Conversely, it accepts the highest selling price.

An asset that is in high demand has a smaller spread as market participants compete with each other and narrow the spread. Popular cryptocurrencies usually have high liquidity.

What are the types of price slippage?

The difference in the order execution price can be both positive and negative for the trader. Most often, slippage is considered a negative phenomenon, but in rare cases it can play into the hands.

If the actual price of the executed buy order is lower than expected, the slippage is considered positive, as it provides the trader with a better bid at a lower price.

If the final price of an order to buy a cryptocurrency is higher than expected, negative slippage occurs, and ultimately the user receives less favorable conditions. This also applies to requests for the sale of an asset.

As a rule, the difference in price occurs when market orders (Market) are executed. Suppose the current price of a crypto asset is $100. An investor wants to sell 20 coins and expects to receive $2,000 for them.

However, before the order is executed, the price of the asset drops sharply to $98. This results in a loss of $2 for each of the 20 tokens. The slippage value in this case is 2% and means a loss for the trader in the amount of $40.

How to avoid price slippage?

To completely eliminate or minimize the risk of slippage, it is recommended to avoid Market orders, at least during periods of high volatility in the market, and use limit orders.

This type of application is available on all centralized cryptocurrency exchanges, but is absent on decentralized sites with rare exceptions (for example, in 1inch). Added to this is a fairly high risk of order execution taking too long due to on-chain operations.

However, there are several basic ways to reduce the risk of price slippage when trading cryptocurrencies on the DEX:

1. If you are trading on an Ethereum-based protocol, we recommend increasing the amount of gas used, otherwise the trade may “freeze” for a long time, up to several hours. The current optimal gas level can be viewed, for example, on Etherscan.
2. Leading DEXs on Ethereum often support second-level (L2) solutions, the use of which can significantly speed up order execution and reduce transaction costs.
3. Many decentralized platforms allow you to manually set the maximum possible price slippage when sending an order.

Some centralized platforms for trading crypto assets have special mechanisms to prevent slippage. For example, Coinbase temporarily locks in a price to fill an order while the user is reviewing the details of the transaction.