Why Does Price Slippage Happen When Trading Cryptocurrencies?

When a market order is executed on an exchange at a price that is different from the price that was indicated in the order, this phenomenon is known as price slippage.

This pattern is common for all assets, including cryptocurrencies, and should not be surprising. The field of decentralized finance (DeFi), more specifically decentralized exchanges, is where price slippage occurs the majority of the time (DEX).

How Does Price Slippage Work?

When a user places a market order on an exchange, they do so with the expectation that the order will be executed at the price that they have set. On the other hand, the actual execution could be different in a way that is unfavorable; this phenomenon is known as price slippage. It is determined as a percentage of the transaction’s base value and is computed as follows:

Slippage can occur when there is a low volume of an asset in the order book as well as when there is a high spread, which refers to the difference in price between the selling price and the buying price of this asset. Also, a too high level of volatility or, on the other side, an inadequate amount of liquidity. When it comes to transactions that take place on the chain itself, the rate at which those transactions are confirmed in the blockchain is of critical importance.

It is feasible to sell or purchase as many cryptocurrencies as possible at a variety of prices if there are a significant number of players, a high level of trading activity, and huge volumes of assets in the glass. All of these factors contribute to a high level of liquidity. Under these circumstances, the likelihood of a trade involving price slippage being profitable is nearly equivalent to zero.

Why is It so Typical for Prices on Decentralized Crypto Exchanges to Slip?

The issue of limited liquidity has been remedied for some time now by using large, centralized cryptocurrency exchanges. Despite this, they are nevertheless susceptible to the occurrence of certain circumstances that can result in price slippage. For instance, this may take place whenever there are sudden shifts in the price of either the entire cryptocurrency market or a single prominent crypto asset. Because of the sharp increase in trading volume, the trading system will be unable to process the flow of applications in a timely manner because it will not have enough time.

A danger that is even more substantial for the DEX is the possibility of a significant delay in the execution of an order. The trading that occurs on these sites takes place within the blockchain and is wholly dependent on its operation. For a transaction to be carried out, a fresh block of data must first become available. It is possible for users of a trading protocol to experience price slippage even during periods that are considered to be “calm” if the network that the protocol utilizes is slow.

Slippage has very little impact on price in the vast majority of transactions. Slippage, on the other hand, is more easily recognizable in situations where the market for a particular instrument is active, such as during a bull market.

Although there is a growing share of productive blockchains in DeFi, such as Avalanche, BNB Chain, or Polygon, as reported by DeFi Llama, approximately sixty percent of all locked liquidity is held in Ethereum, which has a low throughput.

How to Avoid Price Slippage?

It is advisable to avoid placing Market orders altogether or at least during times of extreme volatility in the market and instead use limit orders in order to totally remove or at least significantly reduce the risk of slippage.

This kind of application can be found on all centralized cryptocurrency exchanges, but it is nearly impossible to find on decentralized websites, with only a few notable exceptions (for example, in 1inch). In addition to this, there is a somewhat high possibility that the order execution will take an excessively lengthy time because of on-chain procedures.

When trading cryptocurrencies on the DEX, there are, nevertheless, some fundamental strategies to limit the danger of price slippage, which are as follows:

• If you are trading on a protocol that is based on Ethereum, we strongly advise you to increase the quantity of gas that is used; otherwise, the deal may “freeze” for a significant amount of time, possibly even several hours. Etherscan is one tool that may be used to get an idea of the best gas level at the moment.
• Second-level (L2) solutions are frequently supported by leading decentralized exchanges (DEXs) built on Ethereum. When these are utilized, order execution can be greatly sped up, and transaction costs can be significantly reduced.

When placing an order on many decentralized platforms, you will have the ability to manually select the amount of price slippage that is acceptable.Certain centralized platforms for trading crypto assets come equipped with their own unique set of anti-slippage features. As an example, Coinbase will provisionally secure pricing in order to fulfill an order even if the user is still analyzing the specifics of the transaction.