Intermediate
If you've ever bought or sold cryptocurrencies, you may have noticed that the final price of your transaction wasn't exactly what you expected. Well, that's called slippage. But why does this happen, and how can you avoid it? This article will explain everything, with concrete examples and practical tips.
Table of contents
Understanding slippage in crypto
Slippage refers to the difference between the expected price of a transaction and the actual price at which it is executed. In other words, it's that sometimes frustrating discrepancy that can occur when buying or selling cryptocurrencies. This phenomenon is particularly common in volatile markets like the crypto market, where prices can fluctuate in seconds.
The main causes of crypto slippage
Slippage, the phenomenon where the execution price differs from the expected price, can occur for several reasons. Here is a detailed analysis of the three main factors:
Crypto volatility
Cryptocurrencies are known for their rapid and unpredictable price fluctuations. For example, an asset can change by 1 to 2% in a matter of seconds. If you place an order at a certain price, that price may have changed before your transaction is executed. As a result, your order adjusts to the new price, causing slippage.
The lack of liquidity
The order book, which lists all buy and sell orders for a cryptocurrency , plays a crucial role. If there aren't enough orders matching your desired price, your transaction will have to be executed at different price levels to be completed.
How does it work?
Suppose you place a buy order for 10 ETH at $1,600 each , but the order book only contains 5 ETH available at that price. To execute the remaining 5 ETH, the system will need to "search" for offers at higher prices (for example, $1,610 or $1,620). This process is known as "eating" multiple levels in the order book .
The larger your order volume, the greater the risk of it exceeding a single price level in the order book, thus increasing the risk of slippage. If you are trading an illiquid cryptocurrency (low trading volume), this phenomenon is amplified because there are fewer bids or offers available at each price level.
Important orders and their impact
Large orders amplify this slippage phenomenon. Indeed, a large order can absorb several price levels in the order book , increasing the gap between the initial and final execution prices.
Concrete example:
- You want to buy 100 ETH on a market with low liquidity.
- The order book offers the following prices:
- $1,600 for 50 ETH,
- $1,620 for 30 ETH,
- $1,650 for 20 ETH.
- Your order will result in slippage, as it will have to be spread across these three price levels. You will therefore pay an average of $1,616 per ETH instead of the expected $1,600.
Slippage management: platform settings and behavior
When the order book does not contain enough bids or offers, several scenarios can occur depending on the parameters defined by the trader and the rules of the platform.
How to measure and anticipate slippage?
To measure slippage, most DEXs allow you to define a slippage tolerance. For example, on Uniswap, you can choose an acceptable percentage (1%, 2%, etc.). This prevents your transaction from going through beyond this margin.
Strategies to reduce slippage
- Split your orders : Divide a large order into several smaller ones.
- Favor liquid markets : Trade on platforms where the trading volume is high.
- Use limit orders : This ensures that your transaction will not be executed beyond a defined price.
How does a liquidity pool work on a DEX?
A liquidity pool is a reserve of two assets, such as ETH and USDT , provided by users called liquidity providers (LPs) . These LPs deposit equivalent amounts of both assets into a pool to facilitate trading, and in return, they receive liquidity tokens , which represent their share of the pool.
When a user wants to exchange one asset for another on a DEX, the protocol retrieves the assets directly from the pool. For example, if you exchange 10 ETH for USDT :
- The 10 ETH are added to the pool.
- An equivalent amount of USDT (calculated based on the AMM formula , or automatic market maker) is withdrawn from the pool and transferred to your wallet .
The price of assets is determined by the ratio between the two reserves in the pool, according to the equation x×y=k, where and represent the reserves of the two assets and is a constant. If the ratio of the assets changes, their price also changes. Therefore, the larger a transaction is relative to the size of the pool, the more it unbalances the ratio between the two assets, increasing slippage .
Slippage: positive or negative?
- negative slippage is more common: you pay more (or sell at a lower price) when your order lacks liquidity.
- However, if the market moves in your favor, you can benefit from positive slippage : a better execution price than expected. This phenomenon generally depends on the volatility at the time of the transaction.
Adjusting the slippage
- Trading platforms, particularly DEXs (like Uniswap ), allow you to set a slippage tolerance . For example, a 1% setting means your trade won't execute if the slippage exceeds this limit. This protects traders from excessive price fluctuations.
What happens if there really is no corresponding order?
- If no level in the order book matches your price or tolerance, the order fails and is not executed. On a DEX, this can also result in lost gas fees, as the Ethereum charges for the attempt, even if it fails.
What happens if the pools have different proportions between platforms?
The proportions of assets in pools can vary from one platform to another, which could theoretically lead to price discrepancies between DEXs. However, in practice, these price differences are quickly corrected thanks to the activity of arbitrageurs , specialized traders who exploit price differences between platforms to make a profit. For example:
- If the price of ETH is lower on Uniswap than on SushiSwap , an arbitrageur will buy ETH on Uniswap and immediately resell it on SushiSwap.
- These transactions balance the proportions in the pools concerned, thus synchronizing prices across the different platforms.
Arbitrageurs for imbalances caused by liquidity fluctuations. This dynamic ensures that, despite different proportions in each DEX's pools, asset prices remain broadly aligned with the market.
What happens if the pool lacks liquidity?
If a pool does not contain enough of an asset to satisfy a transaction, several consequences may occur:
Increased slippage: When the pool is unbalanced, the AMM formula will adjust the price significantly to compensate. For example, if a user attempts to withdraw a large amount of USDT , the price of ETH will rise sharply because the remaining proportion of ETH in the pool will decrease. This results in higher costs for the trader.
Transaction failed: If slippage exceeds the user-defined tolerance (e.g., 1%), the transaction is automatically canceled to prevent excessive losses. However, the gas fees incurred to initiate the transaction are lost, which can be costly on blockchains like Ethereum .
Complete depletion of an asset: If a pool is completely empty for a specific asset, it becomes impossible to execute transactions involving that asset. This reflects a low liquidity , which is often a challenge for DEXs dealing with less popular cryptocurrencies.
To mitigate these risks, traders should monitor pool size and liquidity before executing trades. Adjusting slippage tolerance in the DEX settings is also crucial to limit losses in the event of pool imbalances.
The impact of market makeron slippage: why do they get involved?
Market market maker are essential players in financial markets, including cryptocurrencies. Their role is to continuously provide buy and sell orders on exchange platforms, thereby increasing liquidity and reducing the risk of slippage . But why do they invest time and resources to play this role? Quite simply, because they derive strategic and financial benefits from it.
How do market makerreduce slippage?
By offering a wide range of buy and sell orders at different prices, market makerfill gaps in the order book, making transactions smoother. This ensures that a trader can execute a trade at the desired price or with minimal slippage, even for high volumes.
For example, if a trader wants to buy a large amount of ETH on a centralized exchange ( CEX ), the presence of a market maker with sell orders at different levels allows this demand to be met without significantly destabilizing the market. Without market maker , such orders would lead to sharp price fluctuations.
Why do market makerdo this?
market makerdon't provide this liquidity out of pure altruism. Here are the main reasons that motivate them to act:
Profiting from the difference between bid and ask prices ( the spread ) : market maker place orders slightly below the current price to buy and slightly above it to sell. This difference, called the spread , represents their profit on each transaction. On large volumes, even small spreads generate substantial profits.
Platform compensation : Many platforms, such as Binance and Coinbase , incentivize market maker by offering reduced trading fees or even bonuses. In return, these market maker ensure greater liquidity, which attracts more users to the platform.
Portfolio management : market maker also optimize their portfolios by strategically buying and selling assets. This allows them to profit from market movements while minimizing risk.
Increased influence on markets : By playing a central role in liquidity, market maker can also indirectly influence market conditions. This gives them a strategic advantage over other participants, particularly in volatile markets like cryptocurrencies.
Concrete Example: Jump Trading
Major players like Jump Trading are actively contributing to reducing slippage on exchange platforms. By injecting consistent liquidity into digital assets, they stabilize prices and make trading more attractive to traders. For example, on a platform like Binance , their regular orders prevent large price imbalances, even during significant market movements.
In short, market makerdo more than simply facilitate smoother transactions for traders; they also play a strategic role by exploiting volatility and leveraging their privileged market positions. Their presence is a crucial pillar for mitigating slippage risks and maintaining dynamic and liquid markets.
Conclusion and outlook on crypto slippage
Slippage is an unavoidable reality of crypto trading, but it can be managed with the right strategies. Whether you're using a CEX or a DEX, or trading perpetuals , understanding this phenomenon is essential for optimizing your trades.
Crypto Slippage FAQ
What is slippage in crypto?
Slippage refers to the difference between the expected price and the actual price of a transaction.
Can slippage be completely avoided?
No, but you can reduce it by using limit orders and choosing liquid markets.
Why is slippage more common on a DEX?
DEXs rely on liquidity pools, which can lead to large price fluctuations for low volumes.
Which types of traders are most exposed to slippage?
Traders making large transactions or operating in illiquid markets.
Want to learn more? Click on the bold words to explore our articles on perpetuals , the difference between CEX and DEX , and the role of market maker in improving your trading strategies.
Cryptocurrency investments are risky. Crypternon investment advice .
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Yoann
Training engineer, I quickly became interested in the field of finance. Convinced that decentralized finance has a bright future ahead of it, I participate in its democratization by developing Crypternon.
