What is Slippage?
Slippage occurs when the final price of a cryptocurrency trade differs from the price you expected at the time of placing the order. This happens because cryptocurrency markets are highly dynamic, and prices can fluctuate rapidly between the moment you initiate a trade and when it is completed. Slippage is a common phenomenon, especially on decentralized exchanges (DEXs) and during periods of high market volatility.
Types of Slippage
- Positive Slippage: Occurs when you receive a better price than expected. For instance, if you place a buy order at $100 but the trade executes at $99, you benefit from positive slippage.
- Negative Slippage: Happens when the price is worse than anticipated. For example, if your order to buy at $100 executes at $101, this is negative slippage.
While positive slippage can be a pleasant surprise, negative slippage can result in higher costs or fewer tokens than planned.
Managing Slippage
To manage slippage, traders often use a tool called “slippage tolerance.” This is a predefined percentage that indicates how much price movement you are willing to accept before your trade is canceled. For example:
- Setting a low slippage tolerance (e.g., 1%) minimizes the risk of overpaying but may cause the trade to fail if the market moves too quickly.
- Using a higher slippage tolerance (e.g., 5%) increases the likelihood of the trade being executed but might expose you to paying more than expected.
Slippage tolerance is particularly useful on DEXs, where prices can change quickly due to the lack of centralized order books and liquidity fluctuations.
Example of Slippage in Action
Suppose you want to trade 1 ETH for a newly launched token on a DEX. You set your slippage tolerance at 3%. If the price of the token increases or decreases by less than 3% before the trade is executed, your transaction will go through. However:
- If the price rises beyond your tolerance, the trade may fail, or you might receive fewer tokens.
- If the price drops, you could benefit from positive slippage and receive more tokens than expected.
Why Slippage Happens
- Market Volatility: Prices can shift rapidly in response to high trading activity or news.
- Low Liquidity: In illiquid markets, large trades can impact prices significantly, increasing slippage risk.
- Transaction Speed: Delays in transaction processing can cause a mismatch between the expected and executed price.
Reducing Slippage
- Trade during periods of lower market volatility.
- Choose assets or trading pairs with high liquidity.
- Use smaller trade sizes to minimize market impact.
Slippage is a natural part of cryptocurrency trading, and understanding how to manage it effectively can help you execute more successful trades while minimizing unexpected costs.