What is Slippage in Crypto, and How To Change Tolerances
Slippage occurs when the final execution price is different from the expected price of a trade. While slippage can be positive, negative slippage is more likely. When trading with low liquidity pools on volatile markets, slippage can cause huge swapping losses.
Continue reading below, or at learn.liquidloans.io/defi/slippage.
What does Slippage mean in crypto?
Trading platforms use complex systems to fulfill orders both for buyers and sellers. Sometimes there are more buyers than sellers, or there aren’t enough tokens for liquidity. This creates a gap between what buyers are willing to bid and what sellers want to offer. The bigger the gap, the higher the risk of slippage.
Slippage is a price difference caused by price volatility and low liquidity. It happens when you place a market order, but the executed price has deviated. Market orders are instant trades that execute your order at the next best available price.
Low liquidity means there are fewer good prices available on that platform. Maybe you buy the token at $100, but instead, you pay $99, $102, or $120. If the coin itself has low volume, there’s higher slippage
Even though your market order is instant, other orders might have priority. Platforms prioritize earlier (limit) orders, large trades, or swaps with higher fees. By the time it’s your turn, there might not be enough liquidity for your expected price. So the next price available is below your target.
Slippage isn’t a problem on centralized exchanges with millions in liquidity. In DeFi, however, decentralized exchanges (DEXs) rely on liquidity pools funded by other users. The fewer funds are in the pools, the more prices change with smaller orders.
Slippage VS Bid-Ask Spread
A bid-ask spread is the price difference between a coin purchase and .sale. These depend on market maker fees, network costs, and limit orders. Spreads change based on platform liquidity.
Popular cryptocurrencies have low spreads because there’s high liquidity. When trading micro-cap coins, prices might be 10% higher in one DEX than another. The bid-ask spread is known beforehand, so you can use it to your advantage (see crypto arbitrage).
Both terms are correlated because high spreads indicate a higher slippage risk. For example:
- An ERC-20 token might appear on CoinMarketCap for $100
- On a smaller DEX, there’s a 10% spread ($110 bid price and $100 ask price)
- Buying in this DEX would cost at least $110. But because there’s a high spread, slippage is expected. The moment you click buy at $110, you might pay anything between $105 and $115.
Bid-ask spreads tend to be low because there are arbitrage bots balancing pools. In an ideal market, you want 0% spread and slippage. In practice, any slippage below 3% is worth trading.
What is Slippage Tolerance?
Slippage tolerance is the maximum amount of slippage that a trader is willing to tolerate when swapping between two tokens on an exchange. Depending on the exchange, users can usually set a specific maximum amount of crypto slippage they are willing to endure.
To minimize swapping losses, all decentralized exchanges have a minimum tolerance by default. Slippage tolerance allows traders to cancel orders when the executed price changes too much. It’s preset to 0.5% on Uniswap, but you can change it to 0%, 2%, or 100%.
If you fill and order for $100 with 1% slip tolerance, it must execute between $99 and $101. Otherwise, the transaction will fail to protect you from unexpected prices. Note that every cancellation still costs you network fees, so make sure your slippage tolerance is high enough. The lower the coin price, the higher it should be.
When swapping on DEXs, you’ll also find a variable called Price Impact. That’s the slippage caused by you when trading greater amounts than the liquidity allows. Your slippage is someone else’s price impact.
e.g., If your price impact is 50%, you get, at most, half the tokens for the same price. Because liquidity pools try to keep both tokens in 50% proportion by raising prices.
You can play with numbers to find out how many tokens are in the liquidity pool. If your price impact is over 1% for orders below $1,000, there’s too much slippage risk. Many illiquid tokens trade over $100,000+ per day.
If you’re trading coins like Ethereum on big DEXs, there’s minimal slippage risk. If you set the tolerance to 90% by mistake, the difference will still be <2%. The slippage can be as high as your balance allows.
Important: Don’t assume the default rate is the best and always double-check. Some DEXs like Uniswap v3 have auto-features to set slip to ~25% for small orders. You can manually set it below 5%.
Slippage Crypto Example
To simplify, imagine you’re buying 1 ETH at $100. You’re using a DEX (e.g., Curve.fi) where orders execute within seconds, and there’s no bid-ask spread.
- Case A, $110 ETH. Other traders have overbought Ethereum while you ordered and raised the price. Instead of 1 ETH, you get 0.91 ETH due to negative slip.
- Case B, $90 ETH. Other sellers have devalued Ethereum, so you get 1.11 ETH for $100. AKA positive slip.
While unpredictable, negative slip is far more common. Also, note that real-market prices are still $100. Other trading platforms might have slip below 1%.
How to Minimize Slippage Fees
There are better ways to minimize slippage fees depending on where you trade:
Use limit orders
You can guarantee 0% slip when using limit orders instead of market orders. As for 2022, it’s still a missing feature in DeFi (the closest thing is Uniswap’s range trading), but not on centralized exchanges like Binance. If you have the patience, the exchange will fulfill your order at the expected price (or better) when it’s available.
Slippage is minimal on large exchanges. So if you don’t want to miss a good entry price, consider market orders.
Slippage depends on pool liquidity. If you try another DEX instead, you’ll find other pools with hopefully lower slippage. Maybe there’s a bid-ask spread in your favor to compensate.
You can find liquid DEXs on explorers like DeFiLlama or DappRadar. CoinMarketCap shows where most volume comes from. Click here to learn more about Liquid DEXs
Or you can wait a few days until markets stabilize.
Split your orders
If you want to swap $10,000 but there’s only $5,000 of liquidity, find another DEX with $5,000 or more. Splitting orders among DEXs can save over 10% in price impact. For large amounts, they’re worth the extra network fees. Outside Ethereum, it’s almost free.
Use more gas
On Ethereum Mainnet, validators prioritize orders with high network fees. If you’re willing to pay more gas, your order can execute at the expected price before liquidity runs out. You pay lower slip than it shows.
Reduce Slippage Tolerance
If slippage is too expensive, you can try below 0.5%. For smaller coins, you have to decide if it’s worth the risk of failing the transaction and paying network fees. You can set a maximum deadline of 72h on most DEXs to prevent failed orders.
Disclaimer:Please note that nothing on this website constitutes financial advice. Whilst every effort has been made to ensure that the information provided on this website is accurate, individuals must not rely on this information to make a financial or investment decision. Before making any decision, we strongly recommend you consult a qualified professional who should take into account your specific investment objectives, financial situation and individual needs.
Originally published at https://learn.liquidloans.io on September 9, 2022.