Bid-Ask Spread and Slippage Explained

The gap between the lowest price demanded for an asset and the highest price bid is known as the bid-ask spread. Assets with more liquidity and trading volume, such as Bitcoin, have a smaller spread than assets with less liquidity and trading volume.

When a trade settles for an average price that is different from what was originally requested, this is known as slippage. When executing market orders, this is a common occurrence. The final order price may change if there isn’t enough liquidity to complete your order or if the market is turbulent. You can consider splitting your order into smaller portions to avoid slippage with low-liquidity assets.

Introduction

The market pricing of crypto assets is closely tied to supply and demand when you buy and sell them on a crypto exchange. Trading volume, market liquidity, and order types are all crucial aspects to consider in addition to the price. You won’t always get the price you want for a trade depending on market conditions and the order types you utilize.

Buyers and sellers are always negotiating, resulting in a spread between the two sides (bid-ask spread). Slippage (more discussion on this later) may occur depending on the amount of an asset you want to trade and its volatility. Getting a vague understanding of an exchange’s order book will go a long way in avoiding any shocks.

What is the bid-ask spread?

The bid-ask spread is the difference between an order book’s highest bid and lowest ask prices. Market makers or broker liquidity providers often produce the spread in traditional markets. The spread in crypto markets is determined by the difference between limit orders from buyers and sellers.

Accept the lowest ask price from a vendor if you wish to make an instant market price deal. If you want to sell something right away, you’ll accept the highest bid price from a consumer. The bid-ask spread for more liquid assets (such as forex) is narrower, implying that buyers and sellers can execute their orders without generating large price movements. Due to a high volume of orders in the order book, this is the case. When closing big volume orders, a wider bid-ask spread will result in more significant price swings.

Market Makers and Bid-Ask Spread

Liquidity is a crucial notion in financial markets. If you try to trade on a low-liquidity market, you may have to wait hours or even days for another trader to match your order.

Liquidity creation is critical, however individual traders alone do not provide enough liquidity in all markets. Brokers and market makers provide liquidity in exchange for arbitrage profits in traditional markets, for example.

A market maker can profit from a bid-ask spread by simultaneously purchasing and selling an asset. Market makers can profit from the spread by repeatedly selling at the higher ask price and purchasing at the lower bid price. When traded in huge quantities throughout the day, even a slight spread might result in significant profits. As market makers fight and lower the spread, assets in high demand have smaller spreads.

A market maker, for example, would offer to buy BNB for $350 per coin and sell it for $351, resulting in a $1 spread. Anyone who wishes to trade in the market immediately must meet their positions. For the market maker who sells what they buy and buys what they sell, the spread is now pure arbitrage profit.

Depth Charts and Bid-Ask Spread

Let’s look at some real-world cryptocurrency instances to see how volume, liquidity, and the bid-ask spread are related. By switching to the [Depth] chart view in Binance’s exchange UI, you can quickly examine the bid-ask spread. This button is located in the chart’s upper right corner.

The [Depth] option displays a graphical depiction of the order book for an asset. The quantity and price of bids are shown in green, while the quantity and price of asks are shown in red. The bid-ask spread is the difference between these two areas, which you can compute by subtracting the red ask price from the green bid price.

As previously stated, there is an implied link between liquidity and narrower bid-ask spreads. We expect to see higher volumes with narrower bid-ask spreads as a percentage of an asset’s price, as trading volume is a common measure of liquidity. Traders trying to profit from the bid-ask spread are significantly more competitive when it comes to heavily traded cryptocurrencies, stocks, and other assets.

Bid-Ask Spread Percentage

We must evaluate the bid-ask spread of different cryptocurrencies or assets in percentage terms to compare them. The formula is easy:

As an example, consider BIFI. BIFI had a $907 ask price and a $901 bid price at the time of writing. This difference results in a bid-ask spread of $6, which when divided by $907 and multiplied by 100 yields a bid-ask spread percentage of 0.66 percent.

Assume that the bid-ask spread for Bitcoin is $3. While it’s half of what we witnessed with BIFI, Bitcoin’s bid-ask spread is only 0.0083 percent when measured in percentage terms. BIFI also has a smaller trading volume, which confirms our assumption that less liquid assets have wider bid-ask spreads.

We can make some conclusions due to Bitcoin’s lower spread. A lower bid-ask spread means a more liquid item. There is usually less chance of having to pay a price you didn’t expect when you wish to execute huge market orders.

What is slippage?

In markets with high volatility or little liquidity, slippage is a frequent thing. When a trade settles at a price that is different from what was expected or requested, this is characterized as slippage.

Consider the following scenario: you wish to place a large market purchase order at $100, but the market lacks the requisite liquidity to fill your order at that price. As a result, until your order is completely filled, you will have to accept the following orders (above $100). This will result in your purchase’s average price being more than $100, which is known as slippage.

To put it another way, when you place a market order, an exchange automatically matches your purchase or sale to limit orders on the order book. The order book will try to match you with the best price, but if there isn’t enough volume for your preferred price, you’ll have to move up the order chain. As a result of this action, the market fills your order at unexpectedly different pricing.

Slippage is a typical occurrence with automated market makers and decentralized exchanges in the cryptocurrency world. For volatile or low-liquidity alt-coins, slippage can be as much as 10% of the predicted price.

Positive Slippage‍

Slippage does not always imply that you will pay a higher amount than you anticipated. Positive slippage can happen if the price drops while you’re placing a purchase order or rises while you’re placing a sell order. Positive slippage is possible in some very volatile markets, although it is uncommon.

Minimizing Negative Slippage

While you won’t always be able to avoid slippage, there are several tactics you can employ to help reduce it.

  1. Rather than placing a large order, divide it into smaller chunks. Keep an eye on the order book to spread out your orders and avoid placing orders that exceed the volume allowed.
  2. Don’t forget to account for transaction fees if you’re using a decentralized exchange. Some networks charge high fees based on the amount of traffic on the blockchain, which might cancel out any gains you make while preventing slippage.
  3. If you’re dealing with low-liquid assets, such as a limited liquidity pool, your trading activity can have a big impact on the asset’s price. A single transaction may incur minor slippage, but a series of smaller transactions will have an impact on the price of the next block of transactions you make.
  4. Make use of limit orders. When trading, these orders ensure that you get the price you want or better. While you will lose the speed of a market order, you can rest assured that there will be no negative slippage.

Closing Thoughts

Remember that a bid-ask spread or slippage might affect the final price of your trades while trading cryptocurrencies. You won’t always be able to prevent them, but it’s worth thinking about while making judgments. This can be negligible for minor trades, but keep in mind that with huge volume orders, the average price per unit may be higher than planned.

Understanding slippage is a key component of the trading basics for anyone working with decentralized finance. You face a considerable chance of losing your money due to front-running or extreme slippage if you don’t have some basic expertise. That is why the Silver Stonks is here to help you understand more about the basics.

A token on Binance Smart Chain created to help people diversify into digital and hard assets. Check out our whitepaper for more details at www.silverstonks.io.