What Is Slippage? How To Avoid It While Trading Cryptocurrencies?

What Is Slippage in Crypto?

Slippage occurs when a trader ends up buying or selling an asset at a different price than what they had originally intended. This phenomenon is particularly common in fast-moving cryptocurrency markets, where conditions can change rapidly between the time an order enters the market and when the order actually gets executed. As a result, traders often receive a different price than expected, which can significantly impact their trading outcomes and overall profitability.

Crypto slippage can be either positive or negative, meaning that while traders may receive a less favorable price than expected (negative slippage), they might also get a better price (positive slippage). Understanding this dual nature of slippage is crucial for effective risk management in cryptocurrency trading.

Whether slippage occurs or not largely depends on the type of order placed in the market. When a trader places a limit order, they agree to buy or sell a set amount at a specific price, subject to liquidity availability. The primary advantage of limit orders is that they guarantee no slippage, as the trade will only execute at the specified price or better. However, the downside is that limit orders may take longer to fill, or may not get filled at all if market conditions don't meet the specified price.

Slippage typically occurs when traders attempt to buy and sell assets at the available market price by placing market orders. Market orders prioritize execution speed over price certainty, which makes them more susceptible to slippage, especially in volatile or illiquid market conditions.

Volatility and Low Liquidity — Dual Drivers of Slippage

Slippage can occur in the trading of all asset classes, but it is notoriously problematic in cryptocurrency markets. This is primarily due to the asset class's high volatility and often very thin liquidity conditions, particularly in smaller-cap tokens and during off-peak trading hours. Indeed, volatility and lack of liquidity are the two main causes of slippage, and they often work in tandem to exacerbate the issue.

Volatility

Cryptocurrency markets are known for their extreme price fluctuations, which can occur within seconds or even milliseconds. When a trader enters an order expecting a certain price, the market price could move significantly between the time the order is submitted and when it is actually executed. This is especially true during periods of high market activity, such as major news events, regulatory announcements, or significant whale movements.

For example, during a sudden market sell-off or rally, prices can shift by several percentage points in just a few seconds. This rapid price movement means that by the time a market order is processed, the available liquidity at the original price may have been exhausted, forcing the order to execute at a less favorable price.

Thin Liquidity

Liquidity refers to the availability of buy and sell orders at various price levels in the market. In cryptocurrency markets, especially for smaller-cap tokens or during off-peak hours, liquidity can be extremely thin. This means there may not be enough orders on the opposite side of a trade to fill a large order at a single price point.

Imagine that a trader wishes to buy or sell a cryptocurrency at a certain price. If there isn't enough liquidity on the opposite side of the trade at this price to complete the order, the trade would need to execute at multiple price levels where liquidity is available. This could result in an average execution price that is significantly different from what the trader had expected, especially for larger order sizes.

The combination of high volatility and low liquidity creates a perfect storm for slippage in cryptocurrency markets, making it essential for traders to understand and manage this risk effectively.

How Does Crypto Slippage Work? An Example

To better understand how slippage works in practice, let's walk through a detailed example using Bitcoin trading.

Say after seeing Bitcoin offered at $20,000 on an exchange, a trader wishes to purchase one Bitcoin. They place a market order to buy one Bitcoin at the available market price. After a small delay, the trader realizes that they ended up paying $20,050 for one Bitcoin, slightly more than expected. This $50 difference represents an example of negative slippage.

The slippage may have occurred for several reasons. First, there might not have been enough liquidity on the exchange for the trader to buy an entire Bitcoin at exactly $20,000. Perhaps the trader's buy order absorbed all the available sell orders at $20,000, and then needed to match with sell orders at higher price levels ($20,010, $20,030, $20,050) in order to find sufficient liquidity to complete the full order.

Alternatively, market conditions may have changed between the time the order was placed and executed. Other Bitcoin buyers might have managed to snap up the available liquidity at $20,000 first, or sellers at $20,000 suddenly pulled their offers due to changing market sentiment or news events. In fast-moving markets, even a delay of a few seconds can result in significant price changes.

Had the trader secured one Bitcoin for under $20,000, that would have represented positive slippage. For instance, if they paid $19,950 instead of $20,000, they would have benefited from a $50 positive slippage. A sudden influx of sell orders at slightly lower prices, perhaps due to panic selling or a large market maker adjusting their quotes, could explain this positive slippage.

Now imagine the reverse situation. A trader sees the price of Bitcoin at $20,000 and wants to sell one Bitcoin directly at the market price. If they receive more than $20,000 (for example, $20,050), this would represent positive slippage, as they got a better price than expected. Conversely, if they receive less than $20,000 (for example, $19,950), this would be negative slippage, meaning they got a worse price than anticipated.

How To Calculate Crypto Slippage?

Understanding how to calculate slippage is essential for traders to assess their trading costs and optimize their strategies. Slippage can be expressed in either a nominal (currency) amount or as a percentage, with both methods providing valuable insights.

In the example above, where a trader expected to buy one Bitcoin for $20,000 but ended up paying $20,050, the nominal slippage is -$50 (negative because it's unfavorable to the trader). To calculate the percentage slippage, we use the following formula:

Slippage % = [(Actual Price - Expected Price) / Expected Price] × 100

In this case: [($20,050 - $20,000) / $20,000] × 100 = 0.25%

So the trader experienced a 0.25% negative slippage, meaning they paid 0.25% more than expected.

Let's look at another example with a larger trade. Suppose a trader wants to buy $100,000 worth of Ethereum at an expected price of $1,500 per ETH. They expect to receive approximately 66.67 ETH. However, due to slippage, they only receive 66 ETH, meaning they effectively paid $1,515.15 per ETH on average.

The nominal slippage would be: $100,000 / 66 - $1,500 = $15.15 per ETH The percentage slippage would be: [($1,515.15 - $1,500) / $1,500] × 100 = 1.01%

This demonstrates how slippage can become more significant with larger trade sizes, especially in markets with limited liquidity.

What Is Slippage Tolerance?

Many trading platforms, including both decentralized and centralized cryptocurrency exchanges, allow traders to set a preference for how much slippage they will tolerate. This feature enables market participants to prevent trades from executing if the slippage exceeds a certain threshold, providing an important risk management tool.

Slippage tolerance is defined as the maximum acceptable difference in price between what the trader expects when placing an order and what they are willing to accept when the trade executes. Trading platforms typically express slippage tolerance as a percentage of the total trade value.

For example, if a trader sets a slippage tolerance of 0.5% on a $10,000 trade, the trade will only execute if the final price is within $50 of the expected price. If market conditions would result in greater slippage, the trade will be rejected, protecting the trader from unexpectedly large losses.

Setting an appropriate slippage tolerance involves balancing two competing concerns: setting it too low may result in failed transactions, especially in volatile markets, while setting it too high may expose traders to significant losses if market conditions deteriorate rapidly during trade execution.

Crypto Slippage on Decentralized Exchanges

Decentralized exchanges (DEXs) have gained significant popularity in recent years, offering several advantages over their centralized counterparts. Unlike centralized exchanges, trading on a DEX doesn't require Know Your Customer (KYC) background checks that can be exclusionary, and users maintain full custody of their assets throughout the trading process. Additionally, DEXs offer greater transparency through on-chain transaction records and are generally more resistant to censorship.

However, one of the significant drawbacks of DEXs compared to traditional cryptocurrency exchanges is that they often face worse slippage. Understanding why this occurs is crucial for traders considering using DEXs.

Smart contracts power trade execution on DEXs, which fundamentally differs from the order matching systems used by centralized exchanges. Unlike on centralized exchanges where trades can process almost instantaneously, a trade on a DEX doesn't execute right away. Instead, there is a lag time as the trade transaction is processed and confirmed on the underlying blockchain, just as there is with any blockchain transaction.

This longer delay between transaction submission and transaction execution creates a larger window during which market conditions can change, increasing the likelihood and potential magnitude of slippage. During this delay, other traders' transactions may be processed first, changing the available liquidity and prices in the liquidity pools.

Additionally, DEXs often have lower overall liquidity compared to major centralized exchanges, particularly for less popular trading pairs. This thin liquidity exacerbates slippage issues, especially for larger trades.

Calculating crypto slippage on a DEX follows the same principles as on any other trading platform. For example, if you want to buy $500 worth of ETH using USDC on a major decentralized exchange, the platform will show you an expected price in ETH based on current liquidity pool conditions. Most DEXs allow you to set a slippage tolerance and will also display the minimum expected output of ETH if the maximum slippage is reached, helping you understand the worst-case scenario before confirming the transaction.

How To Avoid Slippage on DEXs

While slippage on decentralized exchanges can be more pronounced than on centralized platforms, there are several effective strategies that traders can employ to minimize its impact.

Pay a Higher Gas Fee

To conduct a transaction on a blockchain network like Ethereum, users need to pay a fee to network validators, commonly called the "gas fee." This fee incentivizes network validators to either stake their crypto to secure the network (in proof-of-stake blockchains) or provide their computing power to secure the network (in proof-of-work blockchains).

When a user submits a transaction to the blockchain, it joins a queue of other pending transactions waiting to be validated and included in the next block. Transactions with higher gas fees are typically prioritized by validators, as they earn more from processing these transactions.

To reduce the problem of slippage on a decentralized exchange, traders can choose to pay a higher transaction fee (gas fee) to have their transaction processed more quickly. By offering a premium gas fee, traders can effectively jump ahead in the transaction queue, reducing the time window during which market conditions might change unfavorably.

For example, during periods of network congestion, the difference between a standard gas fee and a high-priority gas fee might be just a few dollars, but it could mean the difference between a transaction confirming in 30 seconds versus 5 minutes. In volatile market conditions, this time difference can translate to significant slippage savings.

However, traders should weigh the additional gas fee cost against the potential slippage savings, especially for smaller trades where the extra gas cost might exceed the slippage savings.

Trade on Layer 2-Based DEXs

In recent years, the majority of DEXs have been running on Layer 1 blockchain networks. For example, much of the trading that takes place on major decentralized exchanges is powered directly by the Ethereum mainnet. When the Ethereum network experiences congestion, this can significantly slow down trade execution and exacerbate the risk of slippage.

However, Layer 1 networks like Ethereum have developed "scaling solution" blockchains known as Layer 2 protocols. One prominent example is Polygon, which operates as a sidechain running parallel to Ethereum. Transactions on Layer 2 networks are processed much more quickly because the processing doesn't occur on the congested mainchain. Instead, transactions are batched and settled on the Layer 1 network periodically, while individual trades execute almost instantly on the Layer 2 network.

Traders can significantly reduce slippage risk by opting to use Layer 2-based DEXs, which typically offer faster transaction confirmation times, lower gas fees, and reduced slippage. For instance, traders could use exchanges built on Polygon or other Layer 2 solutions, which can process transactions in seconds rather than minutes.

The benefits of Layer 2 DEXs include:

• Faster transaction confirmation (often under 2 seconds)
• Significantly lower gas fees (often under $0.01 per transaction)
• Reduced slippage due to faster execution
• Similar security guarantees as Layer 1 networks

Additionally, as mentioned earlier in this article, traders can adjust their slippage tolerance settings on most DEXs. Setting a low slippage tolerance may prevent a trade from filling during volatile conditions, but it will protect against unexpectedly large losses due to adverse price movements. Finding the right balance based on market conditions and trade urgency is key to effective slippage management.

How To Reduce Slippage on CEXs

Similar to DEXs, traders can also employ various strategies to reduce slippage on traditional centralized cryptocurrency exchanges (CEXs). While CEXs generally offer better liquidity and faster execution than DEXs, slippage can still occur, particularly during volatile market conditions or when trading large positions.

Use Limit Orders

When trading on centralized cryptocurrency exchanges, one of the most effective ways to eliminate slippage entirely is to utilize limit orders instead of market orders. A limit order allows traders to specify the exact price at which they are willing to buy or sell an asset, and the order will only execute at that price or better.

The primary advantage of limit orders is that they completely eliminate the risk of negative slippage. If you place a limit order to buy Bitcoin at $20,000, you will never pay more than $20,000 per Bitcoin. Similarly, if you place a limit order to sell Bitcoin at $20,000, you will never receive less than $20,000 per Bitcoin.

However, limit orders come with their own trade-offs. The main disadvantage is that they may take longer to fill, or may not fill at all if market prices don't reach your specified level. In fast-moving markets, this could mean missing out on trading opportunities. Additionally, if the market moves away from your limit price, you may need to adjust your order, potentially missing the optimal entry or exit point.

For traders who prioritize price certainty over execution speed, limit orders are an excellent tool for managing slippage risk.

Trade During Periods of Low Volatility

Timing can play a crucial role in minimizing slippage. Cryptocurrency markets exhibit predictable patterns of volatility throughout the day, often corresponding to the opening and closing of traditional financial markets in different time zones.

Investors can reduce slippage by choosing to trade during times of day that typically experience lower volatility. For example, it's generally advisable to avoid trading during the following high-volatility periods:

• The European to U.S. market crossover (around 8:00-10:00 AM EST)
• U.S. market opening hours (9:30 AM - 4:00 PM EST)
• Major economic data releases (employment reports, inflation data, central bank announcements)
• Cryptocurrency-specific events (major protocol upgrades, regulatory announcements, large token unlocks)

Instead, traders might consider executing trades during quieter periods, such as late evening or early morning hours in major financial centers, when trading volumes are typically lower but more stable. While liquidity may be somewhat reduced during these times, the decreased volatility often results in more predictable execution prices and reduced slippage.

It's also crucial to avoid trading around the time of significant market events, such as Federal Reserve meetings, major economic data releases, or anticipated cryptocurrency-related announcements. These events can trigger sudden price movements that dramatically increase slippage risk.

Break Up Large Trades

For traders looking to buy or sell cryptocurrency in significant, potentially market-moving quantities, one effective strategy is to break up large orders into a series of smaller transactions. This approach, sometimes called "order slicing" or "iceberg ordering," can significantly reduce market impact and slippage.

When a large order hits the market all at once, it can quickly exhaust available liquidity at favorable price levels, forcing the remainder of the order to execute at progressively worse prices. By splitting a large trade into smaller pieces and executing them over time, traders can:

• Reduce immediate market impact by avoiding overwhelming available liquidity
• Take advantage of natural market fluctuations to achieve better average prices
• Avoid signaling to other market participants that a large position is being built or unwound
• Maintain more flexibility to adjust strategy if market conditions change

For example, instead of placing a single market order to buy 10 Bitcoin, a trader might split this into 10 separate orders of 1 Bitcoin each, executed over several minutes or hours depending on market conditions. While this approach requires more active management and may result in some trades executing at higher prices, it often results in a better average execution price than a single large market order.

Many centralized exchanges also offer advanced order types specifically designed for this purpose, such as TWAP (Time-Weighted Average Price) or VWAP (Volume-Weighted Average Price) orders, which automatically break up large orders and execute them over a specified time period.

How Much Should Crypto Investors Worry About Slippage?

Being aware of what slippage in crypto is, and understanding how to mitigate its downside risks, is valuable knowledge for all cryptocurrency market participants. However, the practical importance of slippage management varies significantly depending on an investor's trading style, position sizes, and investment timeframe.

For Long-Term Investors

For small-scale crypto investors who conduct transactions on an irregular basis and are looking to hold their cryptocurrency for an extended period (months or years), slippage is generally a minor concern. If a long-term investor experiences -0.5% slippage instead of -0.25% when making an initial purchase, this small difference would likely pale in comparison to the long-term returns (or losses) of the investment.

For example, if Bitcoin appreciates by 100% over a two-year holding period, the difference between entering at a 0.25% slippage versus a 0.5% slippage becomes negligible in the context of the overall return. In this scenario, investors might be better served focusing on fundamental analysis and long-term market timing rather than optimizing execution prices.

That said, even long-term investors making very large initial investments should still pay attention to slippage, as even small percentages can translate to significant dollar amounts on large positions.

For Large-Scale Investors

For institutional investors or high-net-worth individuals executing large trades, even seemingly small slippage percentages can amount to substantial sums of money. A -0.5% slippage on a $1 million trade represents a $5,000 loss, while the same slippage on a $10 million trade represents a $50,000 loss.

For these larger-scale investors, it's definitely worth the time and effort to implement strategies to minimize slippage as much as possible. This might include:

• Using limit orders whenever timing permits
• Breaking large orders into smaller pieces
• Trading during periods of high liquidity
• Utilizing multiple exchanges to access deeper liquidity pools
• Working with OTC (over-the-counter) desks for very large trades

For Active Traders

Cryptocurrency traders who conduct transactions with high frequency, such as day traders and scalpers, should pay particularly close attention to slippage management. These traders typically operate on thin profit margins, and even small amounts of slippage can significantly impact profitability.

For a day trader making 10 trades per day, a -0.25% slippage on each trade compounds to a -2.5% daily cost, which can quickly erode profits or turn winning strategies into losing ones. Over a month of trading, this could amount to a substantial portion of potential profits.

Active traders should therefore implement comprehensive slippage management strategies, including:

• Primarily using limit orders
• Carefully selecting exchanges with deep liquidity
• Avoiding trading during high-volatility periods unless specifically trading volatility
• Monitoring bid-ask spreads before entering trades
• Using advanced order types to minimize market impact

In conclusion, while all cryptocurrency market participants should understand slippage and its implications, the level of concern and effort devoted to managing it should scale with trading frequency, position sizes, and investment timeframes. Long-term investors can generally afford to be less concerned, while active traders and large-scale investors should make slippage management a core component of their trading strategy.

FAQ

What is slippage in cryptocurrency trading? How is it generated?

Slippage is the difference between expected and actual execution prices. It occurs due to insufficient market liquidity or large trading volumes, causing orders to fill at different prices than anticipated, particularly during high volatility.

How does slippage impact my trading profits? How to calculate slippage costs?

Slippage increases trading costs, especially during high market volatility. Calculate slippage cost by multiplying the difference between actual execution price and expected price by your trading amount. Larger trades in low liquidity conditions incur higher slippage.

How to set limit orders to avoid slippage when trading?

Set a limit order by specifying your desired buy or sell price. This ensures execution only at your preset price, eliminating slippage risk. Trade during high-liquidity periods for better price stability and order execution.

How to minimize slippage risk when trading in highly volatile markets?

Avoid peak trading hours by trading during calm market periods. Set appropriate price limits and use smaller trading amounts. Monitor market volatility and execute orders during lower volatility windows to reduce slippage impact.

How does liquidity affect slippage? On which exchanges is slippage typically smaller?

Higher liquidity reduces slippage significantly. Markets with larger trading volumes experience smaller price deviations. Decentralized exchanges allow slippage tolerance settings. Major platforms with high trading activity generally offer lower slippage for popular cryptocurrencies.

Do large orders (block trades) easily produce more slippage? What are the solutions?

Yes, large orders generate more slippage by consuming order book depth. Solution: split big trades into smaller orders and execute gradually to minimize slippage impact and achieve better execution prices.

How do different trading pairs (trading pair depth) affect slippage?

Trading pair depth significantly impacts slippage. Greater depth and higher liquidity result in lower slippage, while insufficient depth or imbalanced order books cause higher slippage. Larger trading volumes on a pair generally reduce price impact.

In bear markets and bull markets, how does slippage perform differently?

In bear markets, slippage typically results in larger losses due to lower trading volumes and wider bid-ask spreads. In bull markets, slippage may be reduced with higher trading volumes, but sudden price surges can still cause significant slippage on large orders.