The definition of slippage and how to avoid it

Imagine: you go to a supermarket where you see something costs 5 dollars. You go to the cash register and expect to pay 5 dollars, instead, however, you are asked to pay 20 dollars for the item you chose. When such a sudden price spike happens in a grocery store, it is pretty unusual and unpleasant, but unfortunately, this phenomenon occurs quite often on crypto exchanges.

When a crypto trader makes an exchange, they expect the purchase or sale of the transaction to occur at the previously agreed-upon price. But when a transaction goes through at a completely different price, this is referred to as slippage.

Slippage in crypto

Basically, slippage is the difference in price between what you expect to get for the cryptocurrency you buy and what you actually get. In the world of cryptocurrencies, there are two leading causes of slippage: liquidity and volatility.

When the price of Bitcoin or other popular cryptocurrencies changes rapidly, they are considered volatile due to how often they trade at different prices. In this situation, crypto-slippage occurs due to sharp price fluctuations, due to which the trading order is executed at a price different from what the trader expected.

Since cryptocurrencies are still speculative, it only takes one headline or tweet to cause a significant increase or decrease in price.

Another reason for cryptocurrency slippage is related to the lack of liquidity. Some cryptocurrencies like bitcoin are prevalent and often traded. Other coins (or tokens) are not traded very often, either because they are new or not popular. As a result, there is a significant difference between the lowest demand and the highest offer, leading to sharp price changes when entering and executing an order.

When an asset has low liquidity, it cannot be easily converted into fiat (cash). Cryptocurrencies that aren’t super popular are still relatively illiquid because they don’t always have buyers (they just can’t be converted to cash if there’s no buyer market). Since there are very few buyers, the number of asking prices will also be limited, resulting in significant slippage.

For example, if no one is willing to buy an asset, the seller may have to hold on to their cryptocurrency for longer than expected. Moreover, the buyer’s price is ultimately willing to pay may be lower than the price the seller is willing to sell the asset for.

If a seller wants to sell their cryptocurrency for $1.50 and a buyer wants to buy that particular asset for $0.50, the market price of that cryptocurrency will suddenly drop from $1.50 to $0.50. Thus, the absence of buyers means a sudden jump in the market price due to this single transaction.

Positive slippage and negative slippage

Slippage can be calculated both in currency and as a percentage, and this can be done by subtracting the price you expected from the price you received. Slippage is not always a negative phenomenon; if your slippage is negative, it means you got a worse price than you expected. But when positive slippage occurs, it shows that you got a better price than you expected.

In other words, if the actual strike price is lower than the expected price for a buy order, this is considered positive slippage as it gives traders a better rate than they originally intended. For example, if you buy 100 units of an asset at $5 each, but the asset price drops to $4.50, your order goes through a total of $450 instead of $500, which means you got a better deal.

If the strike price is higher than the expected price for a buy order, this is considered negative slippage as it gives traders a less favorable bet than they initially tried to fill. For example, if you plan to purchase 100 units of an asset at $5 per asset, but the price rises to $5.50, your order will be filled for $550 instead of $500.

How to avoid cryptocurrency slippage

Since cryptocurrency prices change so quickly, dealing with slippage can seem impossible. But there are some tricks that you need to know before you start trading digital assets.

The best way to limit slippage is to place limit orders for cryptocurrencies instead of market orders. A market order fills as quickly as possible at any current price, which means you have no control over what price you get when the order is executed.

However, a market order is also guaranteed to be filled, especially when trading popular cryptocurrencies, because there will always be an order going in the opposite direction of your order.

A limit order can sometimes help reduce slippage as you can set the highest possible price you are willing to pay for a cryptocurrency or the lowest possible price you are ready to sell it for. But these orders may not be executed because there is no guarantee that the price will remain within the limits you set for the period you selected.

Some crypto exchanges will actually display slippage warnings if you enter an order with a slippage percentage above a certain amount, usually 2% or higher. Most exchanges allow you to adjust your slippage tolerance, which is a percentage you can change depending on the transaction to ensure your order is filled.

However, if your slippage tolerance is too low, be aware that it is unlikely to be filled, especially if you are trading at market peak times. On the other hand, too high a tolerance often results in you paying more than you bargained for. Ultimately, slippage tolerance depends on your personal risk tolerance and strategy.

There is also an exciting concept called “front-running”. Front-running is a stock market term that refers to the use of insider information about upcoming trades to enter the market before competitors. As a result, this is one type of insider trading. Insiders, having the knowledge, can buy an asset before it appears on the exchange, which will ultimately increase its price.

Users can limit front running by splitting one large transaction into many smaller transactions and adjusting for low slippage. Similarly, developers can use pre-launch measures such as transaction privacy and the use of a hidden mempool.

Simply put, you can break large transactions into smaller ones instead of executing them all at once. This reduces the attractiveness of bot-ahead transactions due to the value that can be mined. As a result, the bots will transmit the transaction instead of executing it in advance.

The fact is that the front runner bot scans pending transactions and pays a higher gas fee so that the miners process its transaction first. In this way, bots are ahead of large transactions that affect market prices.

This brings us to the last tip, but rather a hack that increases the chance of avoiding cryptocurrency slippage is to increase the “gas” in your transaction. When you use more gas, your fees may be higher, but your transaction is also executed earlier and goes faster. When everyone is trying to process a transaction, using low or standard gas means your trade can sit on hold for hours while prices change, leading to more negative slippage.

If you are making a large trade, slippage can cost you dearly. Thus, some crypto traders successfully split large purchases into several smaller transactions. You may pay more gas for a few transactions, but you can still get ahead by saving on slippage prevention.

However, apart from these few tricks, traders should be prepared to deal with slippage due to how volatile the market can be, not to mention that low liquidity can mean sudden price spikes.