August 29, 2023
Understanding Slippage in Crypto
Description
Slippage in crypto is a prevalent occurrence in trading activity that, if not properly understood and managed, can result in unanticipated losses. This guide will provide a comprehensive overview of slippage in order to assist cryptocurrency traders in minimizing its impact on their transactions.
We will begin by defining slippage in crypto and comparing it to conventional financial markets. Next, we'll examine the numerous causes of slippage so you can comprehend the contributing factors. Calculating slippage in crypto is essential for quantifying its impact; therefore, we will review the slippage formula and provide examples.
In addition, the guide will describe the primary categories of slippage and strategies for managing slippage in crypto during various market conditions. Finally, we will emphasize important tools, resources, case studies, and lessons learned to assist you in avoiding slippage in crypto. Let's get going!
Getting started
1. What is Slippage in Crypto?
Slippage in crypto is the discrepancy between the anticipated price of a trade and its actual execution price. Slippage occurs in crypto trading when the price of a digital asset decreases between the time an order is placed and the time it is executed.
You place a market buy order for 1 ETH at $10,000, for example. By the time your order is processed, the price has increased to $10,200. Slippage is the $200 difference between your anticipated price of $0 and the actual price of $10,200. You ultimately pay more per ETH than anticipated.
Both ascending and declining markets are susceptible to slippage. In a declining market, a sell order placed at $10,000 may result in a price of $9,800 once the order is executed. The difference of $200 is still deemed to be slippage.
Due to its high volatility, the cryptocurrency market is prone to slippage. Prices can fluctuate drastically in a matter of seconds, resulting in significant slippage even for small crypto orders. In conventional financial markets where prices are less volatile, slippage in crypto is typically lower.
Slippage Reasons
Several factors contribute to slippage in cryptocurrency trading:
Market Volatility
Due to the high volatility of cryptocurrencies, prices frequently fluctuate considerably between the time an order is placed and when it is filled. Volatility spikes increase the probability of slippage in crypto. Major news announcements, exchange outages, and unexpectedly large transactions can all cause short-term increases in volatility.
Order Book Depth
Slippage in crypto is influenced by the depth of the order book, or the number of buy and sell orders available at various prices. Large slippage on market orders is caused by thin order books with low volume. Your order consumes more of the book and must be supplied from further away.
Inadequate Liquidity
Low liquidity coins have larger spreads and order book discrepancies. Attempting to purchase or sell large quantities can significantly affect the market price. Due to a lack of trading volume and demand, less liquid assets tend to experience greater slippage.
High-Frequency Trading
HFT companies use their speed advantages to detect orders entering the market and trade in advance of them. This front-running increases slippage for the original crypto transaction by driving up the price of purchase orders and down the price of sell orders.
3. Estimating Slippage
To evaluate the risk of slippage in crypto on a trade, you must be able to quantify its potential impact. Here are two methods for calculating slippage in crypto:
Slippage in Crypto Formula
(Executed Price minus Expected Price) / Expected Price
This displays slippage as a percentage relative to the expected pricing. For instance, if you expected ETH to trade at $10,000 but your order was executed at $9,500, you would calculate:
(9,500 - 10,000) / 10,000 = - 5% slippage
Real-World Examples
You anticipate that ETH will trade at $1,500, so you place a market purchase order. The cost of the order is $1,530.
- (1,530 - 1,500) / 1,500 = 2% slippage
- You anticipate that DOGE will trade at $0.25, so you place a market sell order. The cost to complete the order is $0.24.
- (0.24 - 0.25) / 0.25 = -4% slippage
You can determine whether a trade is worth the risk by quantifying slippage. Even minor errors in estimation can result in enormous losses due to slippage.
4. Types of Slippage in Crypto
The execution price can deviate from the expected price in several ways, each of which is classified as a form of slippage:
Price Slippage
The most prevalent form of price slippage in crypto occurs when the market price fluctuates between the time an order is placed and its execution. Your order is executed at a different price than anticipated as a result of normal market fluctuations.
Time Slippage
The delay between submitting an order and having it executed is due to time slippage. Even if the eventual fill price meets your expectations, the passage of time causes some slippage.
Execution Slippage
This refers to disparities between the type of order you placed and the manner in which it was fulfilled. For instance, your limit order may be filled as a market order at a worse price.
5. Managing Slippage in Crypto
Slippage in crypto cannot be completely avoided, but there are strategies traders can employ to reduce its impact.
Establish Realistic Objectives
Slippage in crypto is directly proportional to volatility; therefore, reasonable expectations should be held during periods of increased volatility. Major price fluctuations may account for slippage in excess of 2-3%.
Select the Appropriate Order Type
Market orders are particularly susceptible to slippage. Limit orders may incur a fee, but they can offer price protection. Stop orders reduce risk during market declines.
Split Huge Orders
Splitting a large order into smaller portions prevents consuming too much of the order book at once and can reduce slippage in crypto.
Employ Trading Bots
In rapidly altering markets, bots act quicker than people. Automation's pace advantages make it simpler to obtain the best available price.
Diversify Exchanges
Executing portions of a large trade on multiple exchanges exposes you to slightly distinct order books and liquidity pools, thereby reducing slippage in crypto.
6. Instruments and Sources
Here are some helpful resources and tools for analyzing and preventing slippage:
Slippage Calculating Devices
Usually you don't need a slippage calculator device since most Decentralized Exchanges (DEXs) already give you an estimation of the slippage and what is the minimum value you will receive.
Analysis of Historic Data
Consider past instances of elevated slippage in crypto to determine the circumstances that tend to cause it.
Trading Platforms with Slippage Protection
As an added benefit, some exchanges offer guaranteed slippage protection on limit orders.
Lympid offers a slippage limit protection to all buy and sell orders
Limit Slippage on Decentralized Exchanges
Most DEXs already have an automatic slippage cap of around 2.5%, depending on the exchange. But if you want to limit the slippage value you can go to definitions, go to max slippage and custom the value.
7. Case Studies of Slippage in Crypto
Examining how other traders have handled slippage offers concrete examples from which to learn. Here are two instances:
May 2021 Crypto Currency Crash
The crypto markets experienced a tremendous selloff on May 19, 2021, with over $1 trillion in market value vanishing within 24 hours. Many panic-driven sell orders experienced a slippage of over 10% due to the flash collapse. During market manias, traders learned the importance of limiting position size and utilizing stop-loss orders.
Kraken ETH Flash Failure
In June 2017, the ETH/USD order book on the Kraken exchange nearly emptied, causing the price of ETH to plummet from $320 to as low as $0.10 within seconds. During the event, the lack of liquidity caused up to 90% slippage for some market orders. The risk of trading thinly traded pairs on secondary exchanges was witnessed firsthand by traders.
Conclusion
Slippage in crypto is a constant factor in crypto trading that can rapidly transform profitable transactions into losses. This guide has provided a thorough introduction to slippage, from its causes and types to calculating, managing, and averting it in your own transactions. While slippage cannot be eliminated entirely, understanding the techniques and tools that minimize its impact will increase your chances of trading profitably over the long term.
FAQ
What is an example of slippage in crypto?
An example of slippage in crypto is when you buy Bitcoin at $10,000 expecting that price, but the order fills at $10,200.
What is 2% slippage?
2% slippage means the executed price is 2% different from the expected price, like buying ETH at $1,530 when you expected to pay $1,500.
What happens if slippage is too high?
If slippage is too high, you may pay much more for purchases or receive much less for sales than anticipated.
What is a good slippage tolerance in crypto?
A good general slippage tolerance in crypto is 1-2% given the potential for volatility and low liquidity.
