This is a common occurrence for all assets, including cryptocurrencies. Price slippage is most common in decentralized finance (DeFi), specifically on decentralized exchanges (DEX). Slippage in crypto asset trading can be caused by excessive volatility or, conversely, insufficient liquidity. In the case of onchain transactions, the speed of transaction confirmation in the blockchain is critical.

How does price slippage occur?

When a user places a market order on an exchange, he or she expects the order to be executed at the price specified. However, the actual execution may differ in a negative way, which is known as price slippage. It is calculated as a percentage of the transaction’s face value.

Slippage can be caused by a high spread, which is the difference between the asset’s buy and sell prices, as well as a low volume of the asset in the bet.

The presence of a large number of participants, high trading activity, and large volumes of the asset at different price levels in the stack are all indicators of high liquidity, or the ability to sell or buy as much cryptocurrency at different prices as possible. Under such conditions, the likelihood of experiencing price slippage in a trading transaction is practically nil.

Why is price slippage so common on decentralized cryptocurrency exchanges?

Large centralized cryptocurrency exchanges have long since fixed the problems of low liquidity. They may, however, face specific situations that may result in price slippage. This can occur, for example, during sharp price movements of the entire market or a single popular crypto-asset. A significant increase in trading volume means that the trading system will not be able to process the flow of orders in a timely manner.

A significant delay in order execution poses an even greater risk to DEX. Trading on such platforms takes place on a blockchain and is entirely dependent on its performance: to execute a trade, a new block must appear. If the trading protocol’s network is slow, users may experience price slippage even during slack periods.

In most cases, price slippage has little effect. When the market for a specific instrument is active, such as during a bull market, slippage becomes more noticeable.

According to DeFi Llama, DeFi has a growing share of productive blockchains such as Avalanche, BNB Chain or Polygon, but nearly 60% of all blockchain liquidity is in Ethereum, which has low bandwidth.

How is the price spread related to price slippage?

The market spread is the difference in market price between supply and demand that occurs when the market is unstable or insufficiently liquid.

When a user buys “on the market,” they accept the lowest price offered by the seller. When it sells, on the other hand, it accepts the highest price.

A high-demand asset has a smaller spread because market participants compete with one another to narrow the spread. Popular cryptocurrencies typically have a high level of liquidity.

What are the different types of price slippage?

For the trader, the difference in order execution price can be both positive and negative. Slippage is typically regarded as a negative phenomenon, but in rare cases, it can work in the trader’s favor.

Slippage is considered positive if the actual price of the executed buy order is lower than expected because it provides the trader with a better bid at a lower price.

If a cryptocurrency’s final bid price is higher than expected, there is negative slippage, and the user ends up with less favorable terms. This also applies to sell orders for the asset.

Price differences usually occur when market orders are executed (Market). Suppose the current market value of a cryptocurrency is $100. The investor wishes to sell 20 coins and anticipates a $2000 profit.

However, before the order is executed, the asset’s price drops dramatically to $98. Each of the 20 tokens suffers a $2 loss as a result. In this case, the slippage value is 2%, which results in a $40 loss for the trader.

How to avoid price slippage?

To eliminate or reduce the risk of slippage, it is best to avoid Market-type orders, at least during periods of high market volatility, and instead use limit orders.

With a few exceptions, this type of order is available on all centralized cryptocurrency exchanges but not on decentralized platforms (for example, in 1inch). In addition, there is a high risk of order execution taking too long due to onchain operations.

However, when trading cryptocurrencies on DEX, there are several basic ways to reduce the risk of price slippage:

If you are trading in an Ethereum-based protocol, we recommend increasing the amount of gas used; otherwise, the transaction may “hang” for an extended period of time, possibly several hours. The current optimal gas level can be viewed on Etherscan, for example.

Leading Ethereum DEXs frequently support Layer 2 (L2) solutions, which can significantly speed up order execution and lower transaction costs. When sending an order, many decentralized venues allow you to manually adjust the maximum possible price slippage value.

Slippage is prevented by special mechanisms on some centralized crypto-asset trading platforms. For example, while the user reviews transaction details, Coinbase temporarily fixes the price for order execution.

Read more: https://medium.com/@SunflowerCorpAdmin/why-does-price-slippage-happen-while-trading-623c5a4db518