Do DEXs have a Slippage Problem?
I forward part of an article with the permission of the author( Totle ). This article subverts our view of DEXs’ slippage. In fact, the slippage of DEX is even less than CEXs’ on the basis of transaction liquidity.
Regardless of whether you’re a crypto veteran or not, slippage will inevitably impact your trades.
Slippage in Crypto
Perhaps you’re expecting ETH to rally into a bull-run. You check ETH and it has a current bid-ask spread of 308.15 by 308.20. You place your order for 2 ETH and expect it to fill at 308.20. In those few moments before the trade is completed, volatility is causing rapid price fluctuations making your quote inaccurate. The price you actually acquire is 308.30. The 0.10 difference between your expected price of 308.20 and the 308.30 price you received is called slippage.
The frustrating nature of slippage is further complicated by the diversity of exchanges in the cryptocurrency space. Since each has its own unique set of rules to operate by, slippage at each exchange varies. And when an exchange has a low amount of liquidity, fractions of your order can be completed before your order is subjected to higher prices.
For a long time, this was a common concern about DEXs: Since there was a low amount of liquidity, slippage was assumed to be significant.
The Unique World of DEX Slippage
However, DEXs are clever. DEXs stabilize trade prices in ways centralized exchanges neglect.
Here are five interesting examples of how decentralized exchanges use unique liquidity structures to mitigate the issue of slippage:
Uniswap
Uniswap uses an automated market making strategy to manage liquidity and slippage. This is achieved through a liquidity pooling system where liquidity contributors are rewarded with trading fees for supporting the system. By harnessing the power of a network of liquidity providers, Uniswap can fill the orders of all kinds of crypto traders.
Although this seems to create an ideal situation to prevent slippage, Uniswap’s mechanism to prevent users from buying out the entire liquidity pool makes large orders expensive. The larger the fraction of the pool that an order takes up, the higher the slippage premium. As Uniswap grows, this issue will become decreasingly problematic.
Kyber
Kyber uses a unique diversified liquidity system which includes market makers, liquidity pools, token projects, and token holders.
Liquidity contributors interact with Kyber through a smart contract that allows them to set up a reserve. There are three kinds of reserves which participants can set up — a Fed Price Reserve, an Automated Price Reserve, and an Orderbook Reserve — which you can learn more about here. These reserves cater to many different types of market participants which ranges from average crypto users to institutions. Contributors are incentivized to maintain their reserve by earning crypto on spreads.
This diversified model allows Kyber to tap into a large supply of liquidity and foster an ecosystem of crypto usage. This results in minimal slippage fees due to the supply of market participants ready to fill orders.
Radar Relay
0x Protocol’s Radar Relay takes a diversified approach to liquidity as well. Their framework fosters a modular eco-system that supports multiple order books and token owners to collaborate on maintaining the liquidity supply.
Radar Relay is unique in that they place an emphasis on the role of relayers. Since matchmaking directly with market participants can be difficult, relayers play the role of handling matchmaking (and posting the outcome on-chain) to streamline the process. This robust ecosystem supports decentralized trading so effectively that 0x Protocol now touts having the lowest amount of slippage in the decentralized exchange space.
Bancor
Bancor uses a sophisticated self-balancing mechanism which leverages a large reserve of tokens and its own token, BNT. BNT acts as an intermediary in the exchange process by operating as a tool to adjust the balances of reserves. This allows Bancor to bypass matching makers and takers together by first converting a token to BNT and then adjusting the appropriate reserve; so long as a token has a reserve with BNT, Bancor can support the exchange of that token.
Token projects can provide Bancor with a reserve of liquidity for their token by creating a smart-contract with BNT. This mechanism is used to alleviate slippage by creating a vast supply of liquidity interconnected through BNT.
AirSwap
AirSwap’s approach to creating liquidity is through a fully decentralized order book that allows for direct peer-to-peer trading. Makers notify the system that they have an intent to trade and it matches them with a taker. This private price negotiation mechanism prevents front-running while enabling dark pooling.
By decentralizing the order book in a manner that’s reliable for routine trades, AirSwap can remove slippage entirely by autonomously connecting makers and takers.
DEXs are on the Rise
These unique structures for liquidity have minimized the competitive advantage that centralized exchanges had over slippage. However, since each DEX liquidity system has its own advantages and disadvantages, it can be tricky to evaluate which decentralized exchange is offering the best value for your trade.
