When placing a crypto trade, many assume that the trade will be executed at the exact market price they asked for. Unfortunately, markets are rarely that efficient in pricing. The difference between the expected price of a trade and the actual price at which the trade took place is known as slippage. Caused by changes in liquidity or volatility, slippage can have a severe impact on the bottom line of a frequent crypto trader. It is, therefore, crucial to understand slippage and know how to calculate it so that potential losses can be limited.
In this guide, we will define slippage in crypto with an example, explain what causes it, outline how to calculate it, and, most importantly, show how it can be reduced when trading cryptocurrency.
What is Slippage?
Slippage is when a trade or exchange is settled at a different price than the price that was expected. This occurs due to the delay that is often involved between placing an order in the market and the order being executed.
For those new to cryptocurrency trading, it might be confusing to see that exchanges or trades are not being executed at the expected price. This is due to slippage which is a term first coined in the traditional financial markets. Both forex and stock traders experience the same phenomenon. However, it is witnessed prevalently within the crypto industry, due to the high levels of volatility and low volumes that can be associated with some digital assets.
Is Slippage Good or Bad In Crypto?
Slippage can be either positive or negative. In the example of a buy order, positive slippage occurs when the executed price is lower than the order price as it allows the trader to purchase crypto for a better exchange rate. On the other hand, negative slippage occurs when the executed price is higher than the order price. In this scenario, a trader gets a worse exchange rate than the one originally ordered.
In the example of a sell order, everything is reversed. Positive slippage occurs when the executed price is higher than the order price and negative slippage occurs when the executed price is lower than the order price.
What Causes Slippage?
Slippage in the cryptocurrency markets is caused primarily by one of two factors: (1) high volatility and (2) low liquidity markets. With that being said, there are a couple of smaller factors that can also amplify its effects.
- High volatility. Cryptocurrencies are some of the most volatile assets in the world. Prices can fluctuate by 10% on any given day due to a single headline triggering either panic or FOMO. This is far higher than in traditional markets, where daily price swings average 1%-2%. At times when the price is moving rapidly in the crypto market, it can be extremely difficult to fulfill an order at an exact market price. By the time an order has been placed, the market may have already moved, resulting in slippage.
- Low liquidity. The second reason that cryptocurrencies experience slippage is low liquidity Although well-established cryptos, such as Bitcoin and Ethereum, maintain high trading volumes, many cryptocurrencies within the industry are not traded very often. This means that the number of buyers and sellers is less. With fewer buyers and sellers, orders may dramatically jump in price so that they are filled.
For example, let’s imagine that an investor wishes to sell a cryptocurrency for $2.50. A market order is placed. However, due to low liquidity, a buyer does not appear for 24 hours. Unfortunately, the single buyer is only willing to pay $1.50. As a market order, the order is executed at the market price of $1.50, which causes the price of the cryptocurrency to plummet to $1.50.
Alternatively, if liquidity is low, the size of an order can also lead to slippage. For example, if an investor wishes to buy 20 BTC at $10,000 but there are only 15 BTC at that expected price level, the order for the remaining 5 BTC will continue to slip through the order book. The order will slip to the next seller at $10,100, and then the next seller at $10,200 until the position is fulfilled. This results in an average order price that is higher than expected.
In addition to high volatility and low liquidity, the quote currency and leverage can also amplify the effects of slippage.
Most cryptocurrencies are quoted in a fiat currency, such as USD, or in some instances, a stablecoin that is pegged to a fiat currency. For the most part, fiat currencies are stable. But on occasion, volatility can hit the fiat market, which then results in increased levels of slippage within the crypto markets.
Finally, trading can involve the use of leverage. This involves traders borrowing funds from a broker or crypto exchange to potentially amplify rewards. However, leverage can also amplify losses. If markets are volatile and begin to move sharply, the liquidation of leveraged positions can result in even bigger price movements.
What Is The Impact of Slippage?
With time, slippage can be particularly harmful to a trader’s profits.
Slippage can directly impact the entry and exit position of trades. Ideally, trades are planned well in advance with precise market prices in mind. A good trader will have an estimate of the profit or loss expected from entering a position. However, if those market prices change, it could result in a deviation from the trading plan.
If positive slippage occurs, then a trader may be able to enter a trade at a more favorable price. However, more frequently, negative slippage occurs which results in a trader entering at a less favorable price. Negative slippage leaves less room for upside and more room for downside when executing a trade. It is an additional cost to bear. If negative slippage occurs in every position, costs can easily build and eat into overall profits.
How Do You Calculate Slippage?
Slippage is calculated by finding the difference between the expected order price and the price at which the order was filled. The difference between the two provides the dollar amount of slippage.
For example, Investor A wants to buy 1 BTC for $20,000 and, therefore, enters a market order. Unfortunately, between the time that the buy order is placed and then executed, the ask price for 1 BTC moves to $20,200. The exchange executes the trade and buys 1 BTC for $20,200.
The slippage in this example is calculated as: $20,000 - $20,200 = -$200
However, often it can be useful to also to calculate slippage as a percentage. This involves dividing the dollar amount of slippage by the original order amount and then multiplying that number by 100. In the example above, the dollar value of slippage for the BTC purchase was $200. As a percentage, this is calculated by dividing $200 by $20,000 and then multiplying by 100
Slippage as a percentage = ($200/$20,000)*100 = 1%
Example of Slippage in Crypto
Crypto trades or exchanges are usually entered using bid and ask prices.
- Bid. The bid price is the highest price that market participants are willing to pay for crypto.
- Ask. The ask price is the lowest price market participants are willing to sell crypto.
The difference between the bid and the ask price is referred to as the spread. Let’s imagine that Investor A wishes to buy Ethereum. The current ask price for ETH is $1,000 (the lowest price a seller is willing to sell for). Investor A places a market buy order to acquire 1 ETH at the current ask price of $1,000.
However, due to an unexpected news event, the ask price of ETH jumps to $1,050 before the order is executed. As a market order that is completed at the current exchange price, the order is filled at the new price of $1,050. Investor A ended up paying a higher market price than expected; specifically, a $50 negative slippage.
How To Reduce Slippage in Crypto?
Although slippage is more prevalent within the cryptocurrency industry, there are a few things that can be done to help negate the effects of slippage. These include avoiding volatile periods, sticking with highly liquid cryptos, and only entering positions using a limit order can help to reduce slippage.
- Avoid volatile periods. Avoiding volatility is one way to lessen the risk of slippage. Although crypto markets are more volatile when compared with traditional markets, some periods are more volatile than others. In particular, news events can result in dramatic changes to prices, such as a Federal Reserve meeting or upgrade announcements concerning particular crypto. By avoiding these periods, traders have a much better chance of executing orders at the expected price.
- Choose highly liquid cryptos. Popular cryptos with high liquidity offer the best markets for avoiding slippage. More market participants result in more bids and asks, which means market orders are likely to be filled quickly. The quicker an order is completed, the more likely it will be completed at the expected price.
- Limit orders. Slippage is mainly associated with market orders. Market orders are a type of order that is executed instantly at the next available market price. As a result, a trader has no control over where the trade will eventually be executed. Fortunately, there is another type of order that can avoid this discrepancy; limit orders. Limit orders allow traders to define the absolute maximum or minimum price that a position will be executed. Sell orders can be executed at the desired price or higher and buy orders can be executed at the desired price or lower. While there is no guarantee that the price will reach a limit order and, therefore, fulfill a position, this type of order is one of the only ways to completely avoid slippage.
- Slippage tolerance. Some exchange and trading platforms allow users to input and utilize a slippage tolerance tool. This option is available on some of the well-known crypto exchanges and also within automated market makers such as UniSwap, SushiSwap, and PankcakeSwap. Using slippage tolerance, a user can set the maximum percentage of price movement that they are willing to accept and, therefore, avoid excessive amounts of slippage. If the price moves beyond that point, the order will not get filled.
Frequently Asked Questions
One of the best ways to avoid slippage is to use a limit order rather than a market order. Market orders are executed instantly which results in an order being pushed through regardless of the market conditions. In a volatile, illiquid market, prices could change as the position is being executed. In comparison, limit orders allow investors to choose a specific point of entry.
The easiest way to see if slippage had occurred is by looking at the entry price in comparison to the order price. If the prices are different, an amount of slippage has occurred. The greater the difference, the greater the slippage.
High slippage is typically bad for the execution of a trade. High slippage suggests that the market price has moved significantly from the expected order price. If the slippage is positive, this is advantageous for a trader. However, more commonly, slippage is negative, which results in profits being hindered.
Slippage is a phenomenon that results in trades being executed at a different exchange rate than the one expected. While positive slippage can result in favorable entry and exit prices, more frequently, negative slippage occurs, which results in traders shouldering extra costs.
Caused by high volatility or low liquidity, slippage is particularly prevalent in the cryptocurrency markets. Cryptos are the most volatile market class in the world and many new cryptos do not offer consistent trade volumes. As a result, prices can shift dramatically during the execution of a market order.
However, there are several tips for crypto traders to reduce the risk of slippage. To increase the odds of a favorable exchange rate, traders can avoid trading at times of high volatility, enter positions using a limit order, and stick to blue chip popular cryptocurrencies, that offer the highest trade volumes.