Slippage is a common occurrence in cryptocurrency trading, particularly on decentralized exchanges (DEXs) using Automated Market Makers (AMMs). It refers to the difference between the expected price of a trade and the price at which the trade is actually executed. This discrepancy can result in traders receiving less cryptocurrency than anticipated or paying more than initially calculated. Understanding slippage and its causes is crucial for navigating the crypto markets effectively.
Table Content:
How Slippage Impacts Trades
When trading on AMMs, traders incur two types of costs:
- Protocol Fees: A percentage charged by the platform for facilitating the trade (e.g., 0.3% on Uniswap, 0.2% on PancakeSwap).
- Slippage: The difference between the expected and executed trade price.
Example: Suppose you intend to buy 5 BNB at a price of $200/BNB, spending $1,000. After deducting a 0.2% protocol fee:
- Expected: You should receive approximately 5 BNB.
- Reality: You might only receive 4.7 BNB due to slippage.
- Slippage: The difference of approximately 0.3 BNB represents the slippage.
Key Factors Contributing to Slippage
Three primary factors contribute to slippage:
High Market Volatility
Rapid price fluctuations, whether positive or negative, often lead to a surge in trading activity. This increased volume can overwhelm the available liquidity, resulting in significant price discrepancies and slippage. For instance, if you aim to sell ETH at $2,000 but a faster transaction executes at $1,950 before yours, your order will be filled at the lower price.
Insufficient Liquidity
Similar to traditional markets, low liquidity in a specific trading pair can exacerbate slippage. If a large order is placed in a market with limited available assets, the price will move significantly to fulfill the order. This is especially prevalent in smaller or less popular cryptocurrencies.
The image above illustrates a scenario where attempting to swap $2,000 BUSD for ONT on PancakeSwap resulted in a 64% slippage due to low liquidity in the ONT pool.
Front-Running Bots
Sophisticated bots exploit the transparency of blockchain transactions by identifying potentially profitable trades and executing their own orders ahead of them. This practice, known as front-running, can significantly impact prices and contribute to slippage. These bots profit from the price difference created by the user’s larger order. For more information, refer to our article on Front Running Bots.
Strategies to Minimize Slippage
Several strategies can help mitigate slippage:
- Avoid Trading During High Volatility: Refrain from trading during periods of significant market fluctuations.
- Adjust Slippage Tolerance and Monitor Price Impact: Utilize slippage tolerance settings on trading platforms to control acceptable price deviations. Paying attention to the price impact indicator can also help avoid large slippage. High price impact suggests your trade is significantly affecting the market price.
Order book depth on CEX
- Consider Over-the-Counter (OTC) Trading: For large trades, OTC markets can provide better price execution and minimize slippage by directly negotiating with counterparties.
- Utilize DEX Aggregators or Manual Comparison: DEX aggregators like 1inch, Matcha, and OpenOcean route trades through multiple DEXs to find the best price and minimize slippage. For less common tokens, manual comparison across different platforms may be necessary.
Conclusion
Slippage is an inherent aspect of cryptocurrency trading, especially on decentralized exchanges. By understanding its causes and implementing appropriate strategies, traders can minimize its impact and improve their trading outcomes. Factors such as market volatility, liquidity, and front-running bots all play a role in determining the degree of slippage. Utilizing tools like slippage tolerance settings, DEX aggregators, and monitoring price impact are crucial for navigating the complexities of decentralized trading. Careful consideration of these factors will contribute to a more informed and successful trading experience.
