What Is Slippage in Crypto and How to Avoid It?
crypto basics
Cryptocurrency trading involves careful consideration of many different factors. It often includes simultaneously using immediate technical and broader fundamental analysis, watching the charts, and assessing various indicators. With all that information to think about, many don’t notice when a slippage in crypto happens, nor do they even know what it is.
Slippage is a price change that occurs in the middle of a trading process. You can already see how that can cause problems for traders where every single percentage of a portfolio is valuable.
So, how and when does slippage in crypto happen, how impactful can it be, and is there something you can do to avoid it? In this article, we explore the definition of slippage in crypto, its causes, and methods of mitigating it. Let’s get started!
What Is Slippage in Crypto?
Slippage in crypto is a difference between prices when the trade is initiated and when it is executed. It is not a strictly cryptocurrency phenomenon and is present in most trade markets. These discrepancies occur due to several characteristics intrinsic to trading as well as some technical elements.
When a cryptocurrency trader places an order to buy or sell an asset, there might not be enough funds from counterparties to fulfill that order at the requested price immediately. In that case, the initial trader’s order (especially if it’s a significant one) might be filled by multiple other traders at different times and prices.
Simply put, the price slips after a trader initiates a trade, so they end up making (usually slightly) more or less than initially thought. Due to its complexity, the slippage in crypto varies between different blockchains and exchanges and even between other trading pairs within the same trading platform.
Small slippage is a regular occurrence in trading, and it’s usually not something to worry about. However, moderate amounts can add up over time. Sometimes, slippage can be 10% or more, which can result in substantial price discrepancies with big orders.
Of course, not every slippage results in a bad outcome. There are two types, and they are:
- Negative slippage, which occurs when a trade is executed at an unfavorable price
- Positive slippage, which happens to a trader’s benefit and results in more assets being obtained than expected
What Causes Slippage to Happen?
Slippage happens due to the underlying mechanics of financial markets. Some of these mechanisms are even more prominent in the crypto sphere since it’s much younger and smaller than established traditional markets. Let’s examine the key reasons behind slippage in crypto.
#1. Price Volatility
Price volatility is one of the main attributes of cryptocurrencies and one of the key contributors to slippage in trades. The crypto market is comparatively smaller than the TradFi markets. For instance, the global crypto market cap is hovering around $1.5 trillion as of the time this article was written, while the international stock market cap is at $109 trillion.
Because of the size of the crypto market, it takes a moderate amount of funds to move the entire space. As a result, coin and token prices often experience rapid upward trends with just as swift drops. These sudden shifts happen all the time, including in short periods between a trade initiation and execution.
Even with the biggest and most stable cryptocurrency, Bitcoin, slippage is still a valid concern and should be considered, especially in periods of increased market volatility. The issue gets more prominent when trading altcoins with lower market capitalization.
#2. Low Market Liquidity
Low market liquidity means there aren’t enough assets in circulation to fulfill trade orders quickly and successfully. When it comes to cryptocurrencies, liquidity can become a big problem, particularly with low-cap altcoins.
These coins or tokens will have a low trading volume, which means there are few buyers and sellers. In extreme cases, a sufficiently large buy-or-sell order can exhaust the entire market and sometimes still not end up completely fulfilled.
To complete their order, the trader might have to resort to buying or selling assets at progressively worse rates. On the other hand, low market liquidity can be exploited by whale holders, who can use these tactics to influence the price of the asset.
#3. Network Congestion
Network congestion occurs when there’s more activity than the blockchain can handle. Due to their programming and technical limitations, networks have a set number of transactions they can process and confirm in a set period. When the number of trades exceeds the network’s throughput, transactions might get put on hold, and gas fees can increase.
An indirect consequence of network congestion is slippage. Due to the increase in time it takes to process a transaction, the price of an asset can change significantly. The greater the congestion, the longer a trader has to wait for their order to be fulfilled. That means more time for a cryptocurrency to change price, leading to increased slippage.
#4. Technical Issues
Technical issues are not uncommon, as there are many problems that can occur during online trading.
For starters, some issues can happen on the exchange’s end. Both centralized exchanges (CEX) and decentralized platforms (DEX) can experience difficulties due to software bugs, algorithm fixes, or server downtime. These difficulties can result in prolonged response time or even complete shutdowns, both of which can bring about substantial slippage.
On the other hand, technical issues can occur on the trader’s end. The devices used to connect to an exchange and do trades, such as computers, smartphones, or tablets, can perform sub-optimally. Moreover, a fast internet connection is crucial since a slow or spotty one increases the delay between a transaction initiated by a person and its execution.
How to Calculate Crypto Slippage
To calculate crypto slippage, you simply subtract the executed trade price from the current market price. Here’s what the formula looks like:
To put that in an example, let’s say you initiated a trade to sell cryptocurrency at the price of $100. By the time your order executes, the asset’s price drops to $90, which you end up getting. Since you received less than expected, the negative slippage would be $10 in this case.
On the other hand, if the cryptocurrency’s price rose to $105, you’d experience a positive slippage of $5 since you’d get more than anticipated.
Apart from absolute numbers, you can also calculate slippage in percentages. This metric is even more common when using centralized and decentralized exchanges, as it can give you an estimate in advance, regardless of your position size.
To calculate the slippage percentage yourself, you can divide the realized slippage by the asset’s current market price. This is the formula:
Using the example given above, a $10 slippage divided by a $100 asset price would result in a 10% slippage percentage. Many platforms provide estimates in advance, warning traders that their orders can be subjected to slippage. They’ll usually give a slippage percentage, giving traders a heads-up and helping them calculate potential losses due to price differences.
How to Reduce & Avoid Slippage in Crypto
While it’s not always possible to avoid slippage in crypto, there are many actions you can take to reduce it and make your trading outcomes more predictable. So, let’s examine some of the best methods of reducing slippage and avoiding vast disparities in price.
#1. Limit Orders
A limit order is a type of order to buy or sell the cryptocurrency at a stated price or better. This method is perfect for when you want to eliminate any chance of encountering slippage. For example, a limit order to buy 1 ETH at the price of $1,000 will only execute once there’s another counterparty selling it for that price or lower.
However, the downside is that a limit order may never get executed. In a previous example, if the price of ETH drops as low as $1,000.01 before bouncing back, a trader with a limit order won’t buy ETH, thus losing on potential gains if the asset’s price increases. In that case, a market order might be better. It fulfills immediately, at any given price, but at the risk of slippage.
#2. Stop Losses
Stop losses work similarly to limit orders in the sense that they execute automatically once a specified price is reached. Traders commonly use them to prevent unforeseen losses in cases where the asset’s price moves opposite of a predicted trade.
Another benefit of a stop loss is that it prevents slippage. Essentially, it locks up the price of the cryptocurrency and prevents trade execution in case it deviates. However, as the name suggests, it’s a risk management tactic, so it’s only usable for mitigating losses and not winning trades.
#3. Trading Bots
Trading bots minimize slippage caused by various technical issues. These automated trading systems use preprogrammed algorithms to automatically buy and sell cryptocurrency in the trader’s place.
The critical benefit trading bots offer over manual trading is speed and precision. As trading bots continuously monitor the market, they can execute trades whenever needed. Moreover, they can do so almost instantly, far quicker than a human can. Human traders can hesitate, and so the price can change quickly between deciding on a trade and actually initiating it.
#4. Market Analysis
Market analysis is invaluable not only in coming up with trades but also in reducing slippage. By leveraging technical and fundamental analysis to monitor the market, a trader can predict periods of increased volatility.
They can look at more immediate charts and indicators and follow the latest news and happenings in the crypto sphere and the realm of traditional finance. All that information can provide helpful insight into potential network congestion or price unpredictability, all of which can result in increased slippage.
In these instances, savvy traders can simply wait out the instability to avoid higher gas fees and unacceptable slippage. However, it’s important to note that the method isn’t foolproof, as network congestion and extreme volatility often occur entirely unexpectedly in DeFi.
How Much Slippage Can Be Tolerated?
Generally, more slippage in crypto can be tolerated than in other markets. That is because the cryptocurrency market is smaller than the rest and has less liquidity. However, the exact slippage tolerance in crypto varies between traders and often depends on the circumstances.
As a rule of thumb, when active traders encounter volatile markets, they are willing to accept higher slippage to execute fast trades. On the flip side, stable markets allow traders to opt for lower slippage for a more predictable outcome while not losing speed.
Prominent centralized exchanges usually encounter less slippage than decentralized exchanges. Binance, for instance, automatically sets slippage tolerance to 0.5% and also allows traders to adjust it manually. Coinbase shows a warning if slippage goes above 2%.
Most decentralized exchanges allow traders to set slippage percentages for every trade, usually offering preset values like 0.1%, 0.5%, and 1%. Since they generally have less liquidity than centralized exchanges, participants are often accustomed to higher slippage.
Ultimately, there’s no one true value that fits all situations. Conservative traders may tolerate a maximum of 1% slippage, while risk-tolerant individuals continue trading with 5% or more.
Slippage in Different Cryptocurrencies and Networks
Slippage can vary greatly between different cryptocurrencies and networks. That’s because of the main factors that cause slippage in the first place, which we’ve established to be price volatility, market liquidity, and network congestion.
Considering these parameters, it’s clear that the average crypto slippage will always be lower in large-cap cryptocurrencies like BTC and ETH. First, Bitcoin and Ether have much more stable prices compared to low-cap altcoins. As a result, only minor price differences can occur between placing trading orders and executing them.
Furthermore, most centralized and decentralized exchanges have BTC and ETH in some of their biggest trading pairs. These coins are usually paired with stablecoins or each other. That means there’s plenty of liquidity, which additionally lowers slippage.
Other elements to consider are exchanges and trading platforms themselves. Popular centralized exchanges use the order book method to facilitate trading. On top of that, they keep all their customers’ assets in their own wallets.
The consequence of that is that all asset transfers on centralized exchanges are virtual. Coins and tokens don’t move between wallets every time you trade on the exchange, but only once you request a withdrawal. That means there’s no concern for blockchain congestion or transaction times, which means low slippage.
On the other hand, DEX trading always moves assets between wallets, so there’s dependence on the networks’ capacities. Plus, the reliance on network participants to provide liquidity also increases slippage.
Key Takeaways
Slippage is a common occurrence in crypto trading, yet not many traders and investors are aware of it. While removing this phenomenon altogether is impossible, you can improve your odds a lot by understanding it first.
That’s why we’ve explained what slippage in crypto is, what causes it, and how to approach trading to minimize potential losses. While an obvious solution is to use a reputable centralized exchange, it’s important to remember that they have the keys to your crypto. On the other hand, trading on a DEX is fully decentralized but often incurs higher slippage.
Ultimately, it boils down to every trader's needs and preferences. And as the market grows and matures, we may see reduced slippage in the future!
Slippage in Crypto FAQ
What happens if slippage is too high?
If slippage is too high, many exchanges have built-in mechanisms that will prevent the trade from happening. However, traders can manually set up how much slippage they are comfortable with so their trades can go through even with significant numbers.
What is a good slippage tolerance in crypto?
A good slippage tolerance in crypto is generally up to 0.5%. Some exchanges will signal a warning if slippage goes above 2%. On the other hand, there are traders who tolerate 5% slippage and even higher.
Is higher slippage better?
Higher positive slippage (when the trader wins more money than expected) is considered better than lower positive slippage. However, most traders prefer a stable market environment when slippage is low since they can better control their orders and assets.