What is Slippage: The 6 Best Ways to Minimize Slippage

From HODL to BUIDL, FUD, and FOMO, the world of cryptocurrency seems to have a vocabulary of its own.

But ‘slippage’ is not a term that’s exclusive to crypto trading. This phenomenon occurs in equities, bonds, currencies, futures, and all such market venues

Slippage is the price difference or ‘slip in price’ that occurs when you place a buy order and it gets executed at a lower or higher price than intended.

Even though professionals can handle these effects, people who are new to the field can end up paying more as slippage. Therefore, you need to know how to minimize your slippage.

Slippage risks are much higher when the market is extremely volatile. Major economic events such as the crypto ban by China, or its Evergrande debt crisis can trigger wild fluctuations in token prices.

In this article, we will talk more about slippage and how it works. We will also discuss the various ways that can help you reduce slippage and let you get the most out of your crypto transaction.

What is Slippage in Crypto?

Slippage is the difference between the expected price of a trade and the price at which the trade is executed.

The primary characteristic of cryptocurrencies is their volatility. This constant change in market price leads to slippage. It mostly occurs due to a delay between the trade being ordered and the time of execution.

Slippage occurs during periods of higher volatility when market orders are placed or when a large order is executed but there isn’t enough volume at the chosen price to maintain the current bid.

Slippage Due to High Market Volatility

We’ll explain this with an example. Alex wants to buy a particular cryptocurrency. Its market rate at that point in time is $183.50. He places an order for 100 of them with the intention of paying $18,350. 

But before the order is filled, the price has gone up to $183.57. So the order is filled up at this new price and Alex pays an extra amount of $0.07 per share. Therefore, for 100 coins, Alex actually has to pay $7.00 more.

The same situation can be a tad different. By the time Alex’s order fills up, the price goes down. It drops to $183.40. In that case, Alex would end up paying $18,340 and gain about $10 for 100 coins. So what just happened?

Alex has experienced a phenomenon called “Slippage”.

Thus slippage is defined as the difference between the final execution price and the intended execution price.

Slippage can be categorized as positive slippage, no slippage, and/or negative slippage. In the above-mentioned example, the former incident is a case of negative slippage while the latter qualifies as positive slippage. 

Therefore when an order is executed, your transactions can be more favorable, equal to, or less favorable than the intended execution price. This concept is still new amongst crypto investors and can be frustrating sometimes.

As the first factor has already been discussed, let us understand the second one.

Slippage Due to Lack of Volume

Assume that a farmer sells apples for $1 each. A second farmer sells apples for $2 while a third farmer sells for $3. Each of them has 10 apples.

After careful consideration, you decide to buy 10 apples. You approach the first farmer. By the time you do, he has only 5 apples left. The other 5 have been sold. Therefore, you quickly buy the remaining 5 apples for $1 and go to the second farmer to buy 5 more apples.

However, he too has sold his apples and only 3 are left. Therefore, you buy those 3 apples for $2. You still need 2 apples. So you go to the third farmer and buy the 2 apples for $3. 

It means that initially when you had checked the market price of the apples, you had decided to buy them for $1 from the first farmer. But by the time you started the transaction, there wasn’t enough volume because of the increase in demand. Therefore you had to pay more for the 10 apples as initially intended.

Positive vs Negative Slippage

Now that you have understood the concept of slippage, it is important to understand how many types of slippage there are. 

As we have already mentioned earlier, slippage is of two types. 

Positive Slippage

In the case of positive slippage, you end up getting a better value than anticipated. This usually happens when the price of the cryptocurrency drops, giving you more buying power.

Negative Slippage

In case of negative slippage, you get a lower value than expected. This happens when the crypto prices increase leading to a reduced buying power.

If you are a newbie in the world of crypto transactions, this slippage can add to the confusion. The idea that you could pay a higher price than expected for an asset is daunting. 

But there is nothing to worry about. Slippage usually occurs in very small increments. If the market is extremely volatile, a slippage of 0.50 percent to 1 percent may occur. 

Furthermore, if you can execute your transaction in a strategic manner, you can prevent slippage completely.

6 Ways to Minimize Slippage

Slippage can happen in any market but it is a very common occurrence in the crypto markets. Thousands of transactions take place every hour which results in fluctuation of the cryptocurrencies.

1. Reduce Trading During Volatile Periods

The cryptocurrency market is volatile by nature. So telling someone to avoid trading during volatile periods is rather futile advice. But still, there are periods of high volatility and relatively less volatile times.

Morning vs Noon: Depending on which part of the world you are in, you may find that afternoon trading hours are less volatile compared to the morning hours, hence this may be a more appropriate time for transactions.

Monday vs Wednesday: The middle of the week may be less volatile compared to the end of the week or a Monday morning high.

Market moving news events: Major news events can cause high volatility. The biggest slippages occur when major financial announcements are being made. Avoid placing market orders when such market-shaking news is scheduled around the corner.

A company announcement, a change in the government regulations or even a pandemic like COVID can make the prices go haywire. The main reason is that cryptocurrencies do not have a reference price, unlike fiat money. 

“They are worth only what someone will buy them for and what someone else will sell them for.”

Now that we know slippage is inevitable in crypto, let us see what other factors can help minimize slippage.

2. Set the Slippage Tolerance

As an investor, if you set the level of slippage you are ready to tolerate, the broker will fill orders within that tolerance. If it surpasses this threshold, the order will not be filled. 

Normally, traders set their slippage tolerance at 0.10 percent or less. This ensures lesser loss even at the time of massive market instability.

3. Order Types: Market vs Limit Order

To avoid slippage, set ‘limit orders’ instead of ‘market orders’. Limit orders will get executed only at the set prices thus eliminating the risk of slippage. On the other hand, slippage risk is much higher in market orders used for entering or exiting trading positions.

Limit orders do have the disadvantage that it will work only if it reaches the price you have chosen, so you may miss out on an opportunity to buy a crypto token during an attractive dip. So make your choice smartly.

4. Trade Incrementally

Instead of buying a bulk amount of an asset, place multiple smaller trades. This strategy may take a little more time than intended but the amount of slippage can be really low. 

It can be either TWAP (Time-Weighted Average Price) or VWAP (Volume-Weighted Average Price) orders. Let us again cite an example to understand these two terms better.

Volume-Weighted Average Price (VWAP)

You want to purchase bitcoin for a value of $50,000. Instead of placing a market order in one go, you can break it into smaller trades and buy them.

That is like undergoing 10 trades for $5000 each or 50 trades for $1000 each. This would definitely cause lesser slippage than the former one. This strategy is also known as VWAP.

Time-Weighted Average Price (TWAP)

In the case of TWAP, you can choose to place orders for $50 purchase every minute till you purchase $50,000 in bitcoin.

It may take you a few days, but will not cause you much of a spillage.

5. Trade On Popular Exchanges With High Liquidity

Popular exchanges tend to have deeper liquidity pools that decrease the chances of an order slipping too much. To get your orders fulfilled, choose a trading platform with robust liquidity and high trading volumes.

Binance, Coinbase, Kucoin, and FTX are among the best cryptocurrency exchanges for trading Bitcoin and other crypto assets, with reduced risk of slippage. These platforms support high trading volumes.

What is a liquidity pool (LP)?

“Liquidity pools are pools of tokens locked in smart contracts that provide liquidity in decentralized exchanges in an attempt to gain some profit and attenuate the problems caused by the illiquidity typical of such systems.”

In other words, it's a collection of funds that can be used for trading, lending, and more functions in a decentralized system such as cryptocurrency.

Liquidity refers to the ease at which an asset can be converted into one another. Once the traders pool together their tokens to create LPs, the trade starts.

Trade on DEXs with High Liquidity

DEX (decentralized exchanges) such as UniSwap on the Ethereum network and PancakeSwap or ApeSwap on the Binance Smart Chain also have high trade volumes. But it is important to check the liquidity of the coin you intend to trade.

Popular and in-demand coins will always have takers, but you may find fewer buyers for the newer or unknown coins in the market. If you wish to trade such coins, you may need to set a higher slippage tolerance and this can result in a significant loss.

Setting a high slippage can help you get your hands on a brand new token with a low volume of trades. This enables you to ride the pumping up of the new token, but if the dumping happens, you may find yourself unable to sell the tokens without raising the slippage tolerance significantly. This means you may end up buying and selling such tokens at prices far worse than anticipated.

Setting slippage higher than 6% gives you the warning ‘your transaction may be frontrun’.

Front running is a form of market manipulation and insider trading.

In crypto markets, front running means that: anyone (bots, actually) can see this transaction pending in the pool and they may quickly add in their own swap at a higher gas price which tricks you into accepting the worst price of the set tolerance. This enables them to get a chunk of your swap for themselves.

Pump and dump shitcoins can fluctuate wildly and the token price may swing 60 to 70% in just minutes. So when you set high slippage tolerance, you may end up trading at prices beyond your worst expectations.

6. Choose Popular Trading Pairs

To minimize slippage risks, use trending trading pairs with high trading volume.

Cryptocurrency pairs or trading pairs are crypto assets that can be swapped in exchange for each other. For example: ADA/BUSD, BTC/BNB, SHIB/ETH, etc.

Choosing crypto tokens with large market capitalization value, or the popular ones with high trading volumes guarantee lesser slippage. A trading pair with low liquidity can significantly impact trade performance, leading to more slippage than anticipated.

Is Slippage Common in Crypto?

The crypto market is extremely volatile. There is always a price fluctuation depending on the market mood. If the demand is high, the sales go higher and the prices surge. If it is the other way around and the demand falls, the value drops like rocks.

Other factors such as trading rates, company announcements, and government policies keep the market on its toes, changing prices constantly.

By the time it takes for an investor to submit an order and a broker to fill it, the bid-ask spread has likely changed. In fact, often this happens not just once or twice but multiple times within that short span of time.

Before You Go...

Slippage is very much a part of crypto trading. However, a proper strategy can help minimize the effects of slippage.

For starters, steer clear of any transactions when the market is extremely volatile. Refrain from trading when major economic events are happening. These events directly affect the market sentiment, causing token prices to fluctuate wildly. The chances of slippage are high during these times and the changes in price may be much more drastic than expected. So set your slippage tolerance accordingly.

You can also minimize slippage by making use of limit orders instead of market orders so that the order will only be fulfilled at the set price.

Understanding the nuances of the market fluctuation and getting your transaction done in smart ways can minimize your slippage and give you better gains in the crypto markets.