Slippage is a financial concept that affects all market-traded assets including cryptocurrencies. It is often a common occurrence in the fast-moving and often volatile cryptocurrency market. So what exactly is a slippage?
Imagine that you are prepared to make a crypto purchase and hit that ‘Buy’ button. But once the transaction occurs, you realize that the price you ended up paying for the token is different from what you had expected. What you just encountered is a slippage.
So why is it important to know about slippage if you are into crypto trading?
It’s because slippage plays a vital role in influencing the profitability and outcome of your trades. Slippage is much more important in the crypto world because of its highly volatile nature and sometimes thin liquidity.
This article unravels the mystery surrounding slippage in the crypto market. We shall explore what it is, how it affects your trade, what it means for your trading, and share tips and tricks you can adopt to avoid slippage risks.
So, without further ado, let’s dive in.
What is Slippage?
When it comes to cryptocurrency trading, slippage refers to the difference between the price at which a trader makes a trade and the actual price at which the trade is executed.
The concept is crucial to understand if you are actively involved in buying and selling cryptocurrencies as it determines the profitability and outcome of a trade.
Before we get into details of how it works in practice, you need to know the causes of slippage in crypto.
Key Factors Affecting Slippage
Several factors at play cause slippage in the crypto market. Let us take a look at some of them:
- Volatility
Market volatility affects the price you pay for a cryptocurrency. During periods of extreme volatility, the price of a crypto token can change significantly within a brief time, especially between when a trade order is placed and when it is executed.
- Order Size
If your trade order is large, then it may not be filled at a single price point. This will be the case especially if the market lacks the volume to support the trade. What happens then is that parts of the order are fulfilled at increasingly less favorable prices.
- Market Liquidity
Low liquidity markets contain fewer buyers and sellers. What you need to note here is that large orders can disproportionately affect a token’s market price.
- Network Congestion
Network congestion is also a leading cause of slippage. Blockchains can process transactions in a queue. Thus, once you have made an on-chain transaction, it may take a while for it to be processed. At this point, the price at which the transaction is processed may be significantly different from the price at which you placed the order.
We hope you got a glimpse of the leading causes of price slippage when trading cryptocurrencies. Now, let us take a look at the different types of slippage.
Types of Slippage
Slippages can come in different shapes and sizes, and each has its own set of causes and implications. Primarily, there are two main types of slippages that traders will have to encounter in the crypto market, which are:
- Price Slippage
As the name suggests, price slippage occurs when the price at which a trade is executed is different from the expected price when the trade order is placed. This type of slippage is directly linked to the market’s volatility.
- Liquidity Slippage
Liquidity slippage happens when an order is executed at a different price than the initial value due to a lack of sufficient buyers and sellers at the desired price level. If you are selling large quantities of a less desired cryptocurrency, there might not be enough buyers at your asking price, and as a result, parts of your order might be filled at lower prices, leading to slippage.
How to Calculate Slippage?
Now you know what slippage is, its types, and how it can happen. So It is time to learn how to calculate your slippage in a cryptocurrency trade. By estimating your potential slippage, you can determine the outcome of the trade.
Calculating slippage is a rather straightforward process. At its core, slippage is the difference between the expected price of a token during the trade and the actual price the asset was traded at. Slippage is often expressed in percentage value.
The formula for calculating slippage is: Slippage = ((Executed Price – Expected Price) / Expected Price) * 100
Let us take an example of slippage in a buy-and-sell trade.
- Say that you are buying Bitcoin and the expected price of BTC when placing the order is $40,000. But by the time the order was executed, its market price jumped to $40,200.
Then slippage = ((40,200 – 40,000) / 40,000) * 100 = 0.5
The slippage you experienced in this particular trade is 0.5%
- Now let’s imagine that you are selling Ethereum and you expect to trade it at $2,500 per ETH. However, the actual trade was executed at $2,480.
Then sliippage = ((2,480 – 2,500) / 2,500) * 100 = – 0.8%
Your slippage in this trade is against your favor, indicated by the negative symbol. The trade was executed 0.8% below the expected price.
How Slippage Materializes Across Various Blockchains and Crypto Exchanges?
You are now aware of the causes of slippages in the crypto market. But did you know that slippages can vary depending on the cryptocurrencies you trade and the exchanges you trade them on?
Each crypto asset has its level of liquidity and volatility, which directly impacts its slippage. For instance, tokens like Bitcoin tend to have a more stable value, therefore, its liquidity is high and volatility is low compared to a meme token. This results in less slippage when trading BTC.
Compare that to meme tokens, which have higher volatility and less liquidity, and you get more slippage during trades.
This is just one aspect of slippage in cryptocurrencies. It can also vary depending on the platforms you use to trade the assets.
For example, on centralized exchanges (CEX) like Binance or Coinbase, slippage is influenced by the depth of the platform’s order book and trading activity. Since CEXs don’t offer a custodial wallet, your assets are held by the exchange on your behalf. These centralized platforms offer limit orders on trades, meaning you can place a limit on the percentage of slippage that you are comfortable with.
Whereas, in the case of decentralized exchanges (DEX) like Uniswap or Sushiswap, they operate without the supervision of a centralized authority and you access these platforms by linking your crypto wallet to its protocol. DEXs purely depend on the liquidity in the system for executing trades, and therefore are more susceptible to the risks associated with low liquidity. Typically, decentralized exchanges have default slippage rates ranging from 0.5% to 1%, which can be customized by the trader to suit their preferences.
One major advantage DEXs have over their centralized counterparts is that they don’t have the same risks when it comes to accessing your assets. This means you can transact on the platform by trusting the blockchain it is deployed on.
How to Minimize Slippage in Trades?
There are several measures and tips you can use to minimize the impact of slippage on your cryptocurrency transactions, and they are the following:
- Limit Orders
Placing limit orders on trades is a highly effective method to avoid slippage. A limit order allows you to specify the price at which you want to buy or sell a cryptocurrency. This kind of transaction is only executed when the asset’s market value reaches the specified price point, thereby guaranteeing the outcome you desire and avoiding any slippage.
- Avoiding Market Order During Volatility
Market orders can be executed when the asset is trading at its live price, and are instantaneous. However, this trading strategy can be extremely risky in a volatile market. Because there is no guarantee that your outcome will be at the price you executed the trade at, increasing the probability of slippages.
- Stop Losses
Stop losses are another popular method for minimizing potential slippages. By setting a stop loss order, one can restrict the price movement before an order is executed. A stop loss won’t let you execute a trade if the price of the cryptocurrency fluctuates too much. This way you can take charge of your trades while curtailing the risk of suffering significant losses caused by slippage.
- Trading Bots
Automated trading mechanisms like trade bots are an excellent way to reduce slippage. These bots use advanced algorithms to constantly monitor the markets and execute trades much quicker than a normal human could when favorable conditions arise. The bots can execute trades faster and more effectively than humans, thereby reducing the chances of slippage-led losses.
- Trade During Peak Hours
The crypto market’s liquidity can vary depending on the time of the day. Therefore, it is recommended that you trade during peak hours when there is higher market activity. This helps reduce slippage as more buyers and sellers are in the market.
- Avoid Trading During Major Market Events
Significant news related to the cryptocurrency you want to trade can cause sudden market movements that can increase volatility. By timing your trades to avoid these periods, you can reduce the risk of high slippage.
Conclusion
It is crucial to understand the concept of slippage and its importance to the market before embarking on your journey in crypto trading. Slippage helps you evaluate potential gains or losses from a trade by calculating the difference between the current market price and the executed trade price of the token.
There are various strategies that you can use to minimize the effect of slippage on your trades. But keep in mind that slippage is just one piece of the puzzle when it comes to understanding different aspects of crypto trading. Therefore, it is important to thoroughly learn the concept and observe its effect on your trades to become well-equipped to thrive in the volatile world of cryptocurrencies.
FAQ’s
Slippage can be both good and bad depending on the context. In trading, slippage can occur when executing orders at a different price than expected, which can lead to unexpected losses. However, in some cases, slippage can also work in favor of the trader, allowing them to enter or exit positions at better prices than anticipated.
Slippage itself is not illegal; it’s a natural occurrence in trading where the execution price differs from the expected price. However, some instances of slippage may raise concerns if they result from market manipulation or broker misconduct, which can be illegal.
To minimize slippage, traders can use limit orders instead of market orders, specifying the maximum or minimum price at which they are willing to buy or sell. Additionally, choosing highly liquid assets and trading during times of high market activity can help reduce the likelihood of significant slippage.
No, slippage is not a fee. It’s the difference between the expected price of a trade and the price at which it’s executed, resulting from market fluctuations or order processing delays. However, slippage can indirectly impact trading costs by affecting the overall profitability of a trade.
