Slippage is a term that most crypto traders and investors would have come across when using an Ethereum DEX, or any other decentralized exchange.
The potential of blockchain technology has no ceiling. With that being said, it presents somewhat of a UX nightmare for newfound traders. Slippage is one of the common pitfalls that a user could experience when making trades. But, do you know what slippage is, and how you can reduce potential losses? Let’s take a deeper dive.
What is Slippage?
Simply put, slippage occurs when a trader ends up purchasing or selling a crypto asset at a different price to what their order was initially set at. Slippage mainly occurs during the time taken to execute a trade, resulting in the trader getting a different end price. The differentiation between the ask price, and the executed price, is the slippage amount.
Slippage can be positive or negative, as prices can fluctuate up or down, depending on market conditions, liquidity, and other factors.
How Does Slippage Work?
Let’s run through a basic example.
Imagine Ethereum having a current price of $1,500 USD. A trader is looking to purchase 1 ETH at the current Ethereum price, and goes about making a buy order on his/her chosen decentralized exchange. However, during this time – the Ethereum Foundation has dropped bullish news on future upgrades to the Ethereum network – and as a result the price increases by $100 to $1,600. This is a basic example of negative slippage, where the user has essentially lost margin on the trade due to the increase in price.
In the example of a centralized exchange (CEX), the order may be required to buy a variety of orders at different prices in order to find liquidity for the purchase. Slippage occurs on CEXs too, however more-often-than-not feature technologies that mitigate slippage to the end user. Binance’s convert feature is a good example of this.
Slippage works both ways. If the price of Ethereum dropped during the time taken for the trader to execute the trade – to $1,450 for example – the trade would subsequently execute at the lower price, and result in positive slippage.
What are the Main Contributors to Slippage?
As alluded to earlier, the main contributors to slippage amounts are price volatility and available liquidity. Slippage can occur in any form of financial trade, but are particularly prominent in crypto due to the increased volatility seen with asset prices. Moreover, the lack of liquidity in liquidity pools (LPs) seen on some DEXs can contribute to slippage even further, due to the general lack of available liquidity for a particular asset to fulfill a trade at a given time.
When looking at volatility specifically, a trader may look to execute at one given price, however, a fast-moving market like crypto can then cause quick fluctuations.
In regards to liquidity, a trader might not be able to find the opposite side of the trade for which they are looking to make. Therefore, the trade may need to execute at a higher price in order to fulfill the trade.
How to Calculate Slippage?
Slippage can be calculated in either nominal (a currency), or as percentage forms. In the previous example regarding Ethereum, whereby the trader was looking to purchase at $1,500 but ended up paying $1,600, the nominal slippage would be -$100. For percentage, the trader pays: (-$100/$1,500) x 100 = 6.666666666666667%.
What is Slippage Tolerance?
As it says on the tin, tolerance refers to the amount of slippage that a trader will ‘tolerate’ when executing a trade. Typically speaking, this is referred to in a percentage format which gives the trade a guideline as to how far up or down in price the trader is prepared to pay in order to find liquidity.
What can Traders do to Mitigate Slippage?
Avoiding slippage typically comes down to the DEX/CEX the trader choses. If the platform has an abundance of liquidity for a specific asset, then finding opposite sides to execute trades isn’t a problem. Therefore, slippage is reduced due to the liquidity available.
However, there are different technologies available across platforms. In the instance of Integral Link, the DEX utilizes a concept referred to as Time-Weighted-Average-Price (TWAP) trading. This technology is particularly useful when executing large trades, where a lot of liquidity needs to be found in order to execute.
If traders are looking to execute particularly sizable trades, then using Integrals’ TWAP functionality is a great way to reduce slippage, while also minimizing price impact on the wider market. Whale traders, or DAOs looking to move funds from-and-to their balance sheet – find particular benefit when using TWAP.