The crypto market is experiencing a period of extreme volatility, with Bitcoin prices moving up and down nearly 7% in one day. This fluctuation doesn't come as a surprise, given the recent approval of Bitcoin spot ETFs, the potential halving event, and the growing mainstream interest in crypto assets.
However, with these rapid price movements come the inevitable consequences of slippage. But what exactly is slippage in crypto, and how can you combat it?
Crypto Slippage Definition
Slippage in crypto trading refers to the discrepancy between the expected price of a cryptocurrency trade and the actual executed price.
When you place an order to buy or sell a cryptocurrency at a specific price, slippage occurs when the order is filled at a different price than anticipated. A trader may miss out on profit opportunities or incur unexpected costs as a result.
Example:
Let's say you want to buy Bitcoin at $70,000 and place an order for 1 BTC. However, the trade executes at a slightly higher price of $70,200 due to market volatility or liquidity issues. In this scenario, the slippage cost is $200. Therefore, the actual cost of your trade is higher than expected, resulting in a potential loss of profit.
Types of Slippage
There are two main types of slippage that traders may encounter in crypto trading:
Price Slippage
Price slippage is a situation where the final executed price of a digital currency diverges from the initially expected price at the time the order was placed. The market volatility is the primary factor influencing this type of slippage.
For instance, an order to purchase a coin is placed at $100, but during the execution of the order, the price escalates to $102, leading to a $2 price slippage.
The severity of price slippage tends to fluctuate, contingent on the liquidity, trading volume of the digital currency, and general market conditions. Price slippage is more prevalent in highly volatile markets with minimal liquidity.
Liquidity Slippage
On the other hand, liquidity slippage transpires when an order gets executed at a variant price due to the lack of buyers or sellers at the intended price level.
This form of slippage becomes particularly significant when dealing with sizable volumes of less common cryptocurrencies as there may not be ample market participants ready to trade at the intended price, resulting in an order being partially or entirely executed at less than optimum prices.
One could liken liquidity slippage to the process of trading a scarce collectable in a niche market—the price might need to be decreased to attract buyers prepared to pay for this rare asset.
Besides this classification, slippage can also be categorised as either positive or negative:
- Positive slippage: An order gets executed at a better price than initially intended. In other words, the trader benefits from the price difference.
- Negative slippage: An order gets executed at a worse price than intended. In this scenario, the trader loses money.
Key Factors That Affect Slippage
Several key factors influence the occurrence and magnitude of slippage in crypto trades. Understanding these factors can help traders better anticipate and manage slippage. The main factors include:
Market Volatility
Volatility is a common occurrence in the cryptocurrency market. It refers to the rapid and unpredictable changes in the price of a digital asset. During periods of high volatility, prices can fluctuate significantly within seconds, making it challenging to execute trades at desired prices.
Such intense movements can result in price slippage, causing traders to buy or sell at a different price than intended. To mitigate the impact of volatility on slippage, traders can use limit orders instead of market ones when placing trades.
Limit orders allow traders to set a specific price at which they want to buy or sell a cryptocurrency. If the market reaches that price, the trade is executed, ensuring that the order is fulfilled at or better than the specified price.
Liquidity
The level of liquidity in a market can significantly impact slippage. Liquidity refers to the availability of buyers and sellers in the market, which affects how easily assets can be bought or sold at a specific price. In markets with low liquidity, finding matching orders for a trade may be challenging, resulting in increased slippage.
Order Size
The size of an order also matters when determining slippage. When placing large orders, there may not be enough liquidity or trading volume to fulfil the entire order at a single price point. Thus, it can be executed partially at different prices, leading to increased slippage.
To manage slippage caused by order size, traders can break up large orders into smaller ones or use advanced trading strategies to minimise market impact. By doing so, they can reduce the potential for slippage and execute trades more efficiently.
Level of Network Congestion
In addition to market factors, network congestion can also cause crypto slippage. Network congestion occurs when there is a high volume of transactions on the blockchain, leading to delays in transaction confirmations, which causes trades to be executed at prices different from those intended.
Calculating Slippage in Crypto Trades
How to calculate slippage? The process is straightforward. It involves determining the difference between the expected price and the actual executed price, often expressed as a percentage:
Let's illustrate this with a couple of examples:
Example 1: Buying Solana
Let's say you put in an order to buy Solana with an expected price of $180. However, due to market fluctuations and high demand for the cryptocurrency, the execution price ends up being $182.
This means that you have experienced a slippage of 1.11%.
Example 2: Selling Dogecoin
Now, let's look at an example of selling Dogecoin. You put in an order to sell 1000 DOGE with an expected price of $0.2 per coin. However, the execution price ends up being $0.19 per coin due to market conditions.
In this case, you have experienced a negative slippage of -5%. This can be seen as a loss in potential profits, as the execution price was lower than expected.
Strategies to Mitigate Slippage
While it may not be possible to eliminate slippage completely, traders can employ various strategies to minimise its impact on their trades. Here are some effective techniques to reduce slippage:
Put Limit Orders
One of the most successful tactics to diminish slippage is utilising limit orders in place of market orders.
A limit order gives you the ability to establish a precise limit price for purchasing or selling a cryptocurrency. This order will only be processed if the market matches or surpasses your specified price.
Engage in Peak Trading Hours
Market liquidity and trade volumes can fluctuate throughout the day. Trading during peak periods that exhibit heightened market activity can decrease slippage. More market participants are more likely to locate counterparties at preferred prices.
You need to be aware of the time zones and peak exchange hours of the markets you're interested in and schedule your trades accordingly.
Keep Abreast of Market News and Developments
Major news events and market shifts can initiate abrupt price movements and heightened volatility. By keeping updated on news that is likely to affect the cryptocurrency market, you can limit their risk of losing money due to slippage.
Use Different Venues
Diverse trading platforms can have different levels of liquidity, trading quantities, and order book depth. By expanding your platform usage, you can tap into different liquidity sources and potentially diminish slippage.
Exchanges that have the highest liquidity on the market (highest volumes in both spot and derivatives trading) include:
- Binance
- Coinbase
- ByBit
- OKX
- Bitget
Trade Liquid Coins and Tokens
One of the most effective ways to reduce slippage is to trade with high-liquid assets. These digital currencies have large trading volumes and market capitalisation, making them easier to buy or sell without causing significant price fluctuations.
Some of the most liquid cryptocurrencies in the market today include:
- Bitcoin (BTC)
- Ethereum (ETH)
- Binance Coin (BNB)
- Solana (SOL)
- XRP (XRP)
Configure Slippage Tolerance
Slippage tolerance is a term that indicates the highest acceptable discrepancy between the projected price of an asset and the price as it is executed. Setting a slippage tolerance parameter in your exchange establishes your threshold for market price variation when executing trades.
A high slippage tolerance suggests an openness to a substantial disparity from the anticipated price. Conversely, a low slippage tolerance imposes stricter constraints on price deviations, which can result in fewer fulfilled orders.
Adjust Order Size
If order size is a significant factor contributing to slippage, traders can consider adjusting the size of their orders. Divide large orders into smaller chunks to decrease market liquidity impacts and diminish slippage. Additionally, you can apply trade strategies like iceberg orders or volume-weighted average price (VWAP) for more effective large order management.
Conclusion
Slippage is an inherent aspect of crypto trading that can impact the profitability and outcome of trades. Proactively managing slippage can lead to more successful results when trading cryptocurrencies.
Disclaimer: This article is not financial advice. Investing in cryptocurrencies carries risks, and past performance does not indicate future results. Only invest what you can afford to lose, and seek professional advice if needed.
