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In crypto, slippage is like fire.
It can be dangerous, devastating even. Or, it can be a constructive force for good.
The difference comes down to your personal ability as a trader to understand and control it.
So allow me to be your crypto Smokey Bear for a minute and explain slippage. For only you can prevent negative slippage and its long-term impact on your portfolio.
The Short Version:
- In crypto, slippage is the difference between the expected price and the actual price of a buy/sell/trade order.
- Slippage is especially common in crypto, where volatility can lead to the price changing thousands of times before your transaction reaches the market.
- You can protect yourself from “negative” slippage by setting slippage tolerances and limit orders.
What Is Slippage in Crypto?
Slippage is the difference between the expected price of a trade and the actual price.
Let’s say you submit an order to buy some Investor Junkie Coin (IJC) at $1.00 per token (Sadly, not a real coin).
However, due to the coin’s volatility, by the time your trade gets submitted the price has risen to $1.05.
In that case, you’ve just experienced slippage of 5%. And because the slippage worked against you, it’s considered negative slippage.
Now, let’s say that IJC went down to $0.95 instead. Since your buying power just increased, the slippage worked in your favor. That’s called positive slippage.
Same goes for selling. Let’s say you sell your IJC at $1.00 with a slippage tolerance of 10%. Within a few minutes, the sell order goes through with a price of $1.10.
Again, since slippage worked in your favor, that’s positive slippage. If the sale went through at $0.90, that would be negative slippage.
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Why Is Slippage Bad for Traders?
You’ll often hear crypto traders lamenting:
“Ah, the slippage got me!”
“I shouldn’t have aped in to that ICO with a slippage tolerance of 20%.”
While you can definitely be burned by slippage, it’s not always bad. As we’ve shown above, positive slippage can work in your favor, giving you more buying power than you realized.
Then again, some traders would say they’d prefer no slippage at all — positive or negative.
Imagine if Amazon ran a sale where every item you bought either rang up for 80% or 120% of its listed price — and you wouldn’t know which until you’d already paid, no refunds.
Some might find that Russian Roulette exciting, but I’d personally rather wait until prices are more predictable again.
Unfortunately, slippage can’t be completely avoided. It can, however, be addressed and minimized.
How and Why Does Slippage Occur in Crypto?
Slippage occurs because a lot can happen during the average transaction time of popular cryptocurrencies.
For context, here are the average transaction speeds of three major cryptos:
- Bitcoin: 10 minutes to 1.5 hours, traffic permitting
- Ethereum: 5 minutes to 4.5 hours, traffic permitting
- Cardano: 5 minutes
As you can see, even cutting-edge proof-of-stake cryptos like Cardano can’t break the five-minute transaction speed barrier. And within those five minutes, the price of ADA can change thousands of times.
Slippage is a natural market force. Since your broker/exchange is trying to hit a moving target, the price you want and the price you get will almost always be different.
So the first two factors driving slippage are the transaction speed and volatility of the asset: The slower the former, the more the latter can wreak havoc on prices before your trade is executed.
But even low-cap cryptos suffer from slippage, because the other major source of slippage is liquidity.
Let’s say everyone’s HODLing their IJC and no one’s selling. You submit a buy order for 10,000 at $1 with a 5% slippage tolerance. Since no one’s selling, your broker is only able to find 5,000 IJC at $1.04 and another 5,000 at $1.05.
As a result, due to the coin’s low liquidity, you’ll end up buying 10,000 at an average $1.045.
Learn more >>> The ABCs of Cryptocurrency: A Glossary of Common Crypto Terms
Why Is Crypto More Susceptible to Slippage Than Other Financial Markets?
The three main factors driving slippage are:
- Transaction speed
But why is crypto more susceptible to slippage than the stock market? After all, market orders on Charles Schwab are no faster than crypto buys on PancakeSwap, and stocks can suffer from low float, too.
That leaves volatility. The data shows us that the crypto market is unequivocally more volatile than stocks.
Until crypto trades become instantaneous, such a roller coaster will require crypto traders to have a high slippage tolerance in their limit orders — usually around 1%.
How To Calculate Slippage
The formula for slippage is pretty simple; it’s just the difference between the Bid (aka purchase) Price and the Ask Price expressed as a percentage of the Ask Price.
Slippage percentage =
(Bid Price – Ask Price) / Ask Price * 100%
Let’s say you submitted an order for 10,000 IJC at $1.04 and the final price was $1.08.
Your slippage percentage is:
($1.08 – $1.04) / 1.04 * 100% = 3.85%
And there you have it!
What’s the Worst Case Scenario?
With no boundaries in place, slippage could wreak havoc on the markets.
For example, let’s say you wanted to buy $10,000 worth of IJC while the price is $1 per token, but it’s rising. You expect to receive 10,000 tokens, but since the price rockets to $2 by the time your trade reaches the market, you only receive 5,000.
You’re justifiably upset because you never would’ve bought at $2. And if millions of crypto traders never knew the price they’d actually end up paying, the markets would grind to a halt.
Luckily, we have two tools to mitigate the amount of slippage people experience in the markets. Those tools are limit orders and slippage tolerances.
How To Avoid Slippage (or Use It to Your Benefit)
Slippage is a natural market force. Again, a lot can happen in five minutes. Since your broker/exchange is trying to hit a moving target, the price you want and the price you get will almost always be different.
That being said, there are two primary ways to hedge your risk and avoid too much negative slippage.
💡Set your slippage tolerance – Many crypto exchanges will let you set your own slippage tolerance. The standard options typically look like 0.5%, 1%, and 3%. That way, if your slippage exceeds 3% by the time it reaches the market, your exchange will automatically cancel the trade.
💡Use limit orders – Some crypto exchanges borrow the term “limit order” from the stock world, which is a way of telling your broker “Buy/sell at this price or better.” Unlike slippage tolerances, limit orders prevent negative slippage entirely, and can even use slippage to your benefit. The tradeoff is that by refusing to accept any negative tolerance, your order may never execute in the first place.
As a net result, slippage tolerances are better for speed, whereas limit orders are better for hedging risk.
How Do Crypto Exchanges Try To Minimize Slippage?
There are four main ways the big exchanges try to minimize slippage for their traders:
- Enabling custom slippage tolerances and limit orders
- Maximizing transaction speeds on their end (blockchain traffic is out of their hands)
- Setting platform-wide slippage tolerances to 10%, and
- Maintaining liquidity pools
It’s hard to say which platform is “best” for slippage since they mostly talk at a high level and don’t publish hard numbers. But if your main goal is to avoid slippage, you’ll want to stick to a centralized exchange (e.g. Coinbase or Kraken) versus a decentralized exchange (e.g. dYdX or PancakeSwap) for one simple reason: front-running.
Explore more >>> Centralized vs. Decentralized Exchange: Which Is Right for You?
The Problem With Front-Running
Front-running is a form of insider trading in decentralized exchanges where someone uses pending transaction data to manipulate the markets.
It happens in every market, but crypto is especially vulnerable because pending transaction data is technically public. So all the bad guys have to do is run bots that help them trade faster than you. As a result of how “easy” it is, front-runners steal up to $280 million a month.
To defend yourself from front-runners you can do a few things:
- Keep your slippage tolerance low (<10%)
- Avoid low-liquidity pools where possible
- Google “front-running in [token name]” to see if other buyers have detected the presence of a front-runner on a specific blockchain
- Break your large transactions into multiple smaller ones that front-running bots are less likely to detect.
How to protect yourself from other scams >>>
Remember the ‘fire’ simile? There’s nothing wrong with setting a low slippage tolerance or limit order and creating a “controlled fire” for your portfolio. In fact, controlled fires bring warmth and hot dogs.
The key is just to avoid letting slippage grow out of control. High tolerances and front-running can eat away at your crypto investments, so always be aware of your surroundings.
Crypto Smokey out 😎
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