Slippage
On automated exchange platforms, slippage is the difference between the price of an asset at the exact time the order is placed in the market, and the price at which the asset is finally bought or sold. It is closely related to volatility, because the more volatile an asset is, the bigger and more frequent price changes it will have, making slippages more likely and bigger.
For example, if an investor goes to an DEX platform (like PancakeSwap or Uniswap) and places a purchase order of 1 ETH, these systems will wait until there is an equivalent amount of sale orders (in ETH) and automatically make the exchange. During this waiting time, the price of ethereum could have, for example, increased 2%. That will mean that the buyer ended up purchasing 1 ETH 2% more expensive than expected.
Nevertheless, in most DEX platforms, there is a “Liquidity Pool”, where there is an amount of, usually, 2 different currencies, and instead of exchanging the assets directly with other users of the exchange platform, the user puts his assets in the pool, and obtains the equivalent of the other currencies´ tokens in return. This does not eliminate slippages, but reduces the risk of them happening by reducing waiting time (only when exchanging between 2 currencies that are in the liquidity pool).
PROs
- Possible to minimize the risk
- Incentivizes exchange platforms to create liquidity pools
CONs
- Risks of losses when exchanging cryptocurrencies
- Impossible to completely eliminate the risk
Conclusion
Slippages should not be a big concern, but it is important to be aware of them, and the causes that increase the risk (like price volatility due to high market activity, or very low market activity that increases waiting time, etc.). The best thing to do in order to reduce the risk, is to avoid exchanging very big amounts of money at once, put slippage limits on exchanges, and if possible, pay more gas fees.
Analyst Opinion
Slippages happen for 3 main reasons:
- The asset is highly volatile: there are too many price fluctuations
- Market liquidity is low: this means there are not many people trading in the market, which increases the time needed to find someone to fulfil the order. For example, when an investor wants to buy 1 bitcoin, there must be others in the same exchange platform wanting to buy, in total, 1 bitcoin.
- The DEX exchange doesn’t have a big enough liquidity pool: in decentralized exchange platforms, there is a liquidity pool that is usually made of 2 different types of tokens, having approximately 50% of each. Then, when swapping, the investor transfers the tokens to the pool, and gets the equivalent amount of the other token (the desired one) in return. The bigger this transfer is in relation to the size of the liquidity pool, the higher the slippage will be. This is because the investor will be significantly affecting the 50-50 balance of the pool and price will increase to compensate and maintain this equilibrium between the total value of both tokens.
Slippages are not always something to worry about. They should be a concern only when trading on a very small market (for example, with new cryptocurrencies), or when trading a very big amount of money at once.
When swapping in a DEX exchange, one way to reduce slippages as much as possible is to pay more gas fee, in order to make the swap faster. Also, it should be a good idea to set slippage limits in the exchange, and this way, the swap won’t be automatically done if the slippage is too big (most exchanges offer this option).
Another good idea is to avoid swapping big amounts at once, because a slippage of 5% could be very painful for large amounts of money. Therefore, it is wiser to divide the total amount in smaller ones, and exchange them one by one.
Matěj Procházka
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