What is Slippage in Crypto?
On Aug 02, 2022
Slippage is a phenomenon that can occur in the crypto world when traders attempt to execute orders. This can happen when there is a large difference between the buy and sell prices, or when the order size is too large for the available liquidity.
When slippage occurs, the trader may not get the price they expected, which can lead to losses. In this article, we’ll explore what slippage is, how it affects traders and some methods for avoiding it.
Why slippage occurs in cryptocurrency trading
Volatility is one of the most important factors to consider when trading cryptocurrencies. While high volatility can lead to bigger profits, it also means that there is a greater risk of slippage. Slippage occurs when the market moves too fast for your trade to be executed at the price you wanted.
For example, if you’re trying to buy 1 Bitcoin at $20,000, but the market price suddenly jumps to $21,000, you will experience slippage. This can be a major problem when volatility is high, as it can eat into your profits or even result in a loss. That’s why it’s important to always consider volatility when trading cryptocurrencies.
Liquidity risk is the risk that a cryptocurrency cannot be sold or exchanged for cash quickly enough to prevent a loss. This can happen when there are too few buyers or sellers in the market, or when the bid-ask spread is too wide. Slippage is the term used to describe the difference between the expected price of a trade and the actual price.
When markets are illiquid, slippage can be significant, and traders can lose a large portion of their investment. For example, if you wanted to buy cryptocurrency worth $1,000 worth of Bitcoin and the bid-ask spread was $100, you would only get 10 Bitcoin for your $1,000.
This is an extreme example, but it illustrates how slippage can eat into profits in an illiquid market.
Liquidity risk is one of the key risks associated with trading cryptocurrencies. If you’re thinking of investing in cryptocurrencies, make sure to do your research and choose an exchange that is both reputable and liquid. That way you’ll be less likely to experience slippage if you need to sell your position quickly.
Order types are one of the main factors that can cause slippage. For example, if you place a market order for a digital currency that’s not very liquid, your trade might not be executed immediately at the quoted price. Instead, it will likely be filled at a slightly higher or lower price, resulting in slippage.
Limit orders can also cause slippage if the market price moves away from your limit price before your order can be filled. However, you can minimize the risk of slippage by using a stop-limit order, which will only be executed at your specified limit price.
In the world of cryptocurrency trading, slippage often occurs when a trader attempts to buy or sell a large number of coins all at once. When this happens, the market can’t absorb all of the coins being traded at once, and the price starts to drop. As a result, the coins that the trader buys are worth less than the coins that the trader sells.
Trade size is therefore one of the key factors that can cause slippage in crypto trading. By reducing trade size, traders can help to reduce the amount of slippage that they experience.
Trade size is important because it directly impacts the amount of liquidity in the market. The more liquid an asset is, the less likely it is to experience slippage.
On the other hand, illiquid assets are more susceptible to slippage because there are fewer buyers and sellers willing to trade at the current prices.
How to Avoid Slippage?
Although there are benefits and drawbacks of investing in cryptocurrency, one must take certain steps to avoid certain risks including slippage. Some of the ways are explained in that regard.
1. Always use a secure wallet to store your cryptocurrencies
Cryptocurrencies are stored in digital wallets, and if you’re not careful, your coins could be stolen by hackers. That’s why it’s important to use a secure wallet. This way, even if your computer is compromised, your coins will still be safe.
There are many different types of wallets available, so make sure to do your research before choosing one. Once you’ve found a wallet that meets your needs, take the time to set up strong security measures. This may seem like a lot of work, but it’s worth it to protect your investment.
If you don’t have a secure wallet in place, your transaction may not go through at the original price you were hoping for. By using a secure wallet when storing your cryptocurrencies, you can help protect yourself from slippage and other market fluctuations.
2. Make sure that the exchange you are using is reputable and has a good security protocol in place
When you are looking for crypto exchange, it is important to make sure that you select one that is reputable and has a good security protocol in place. This will help to avoid slippage, which can occur when the price of a coin or token changes unexpectedly.
There are a few things to look for when you are evaluating an exchange. First, check to see if the exchange is registered with a regulatory body such as the SEC or FINRA. Next, look at the security measures that the exchange has in place, such as cold storage. Also, now the U.S. is urging the SEC to have proper check and balance against major cryptocurrency exchanges to avoid fraudulent activities.
Finally, check to see if the exchange has insurance in place to protect against loss or theft. By taking these steps, you can help to ensure that your experience with crypto is positive and profitable.
3. Only trade with people you trust – never give away your private key or password to anyone
The reason to only trade with people you trust is to avoid slippage. Slippage occurs when someone tries to sell you a cryptocurrency that they don’t have the private key for. This can lead to a loss of funds, as well as a loss of trust in the person you were trading with.
To avoid this, always make sure that you are the one who holds the private key for any cryptocurrency you trade. If you ever give away your private key or password to anyone, be sure to change it as soon as possible to avoid any potential losses.
By only trading with people you trust and keep your private keys safe, you can help avoid any unwanted slippage in the crypto world.
4. Use two-factor authentication whenever possible
With the rise of cryptocurrency, online security has become more important than ever. There are certain options to safely store your cryptocurrency. One way to protect your crypto investments is to use two-factor authentication (2FA) whenever possible. 2FA adds an extra layer of security by requiring you to confirm your identity with a second device, such as your smartphone.
This makes it much harder for hackers to gain access to your account, as they would need both your password and your second factor. As a result, using 2FA can help you avoid slippage in the crypto markets. So be sure to enable 2FA on all your accounts and never reuse passwords!
5. Regularly check your account for any suspicious activity
To avoid slippage, it’s important to regularly check your account for any suspicious activity. This way, you can catch any sudden price changes and adjust your order accordingly. Additionally, it’s always a good idea to have a backup plan in place in case your order does fill at a lower price than anticipated.
On the other hand, If you’re considering custodial wallets, make sure to do your proper research as they too are a risk of being hacked and in one of the recent events, issues with custodial wallets led people to ask for their money to be paid back and caused major problems for both parties. By taking certain precautions, you can help ensure that you trade cryptocurrencies with minimal slippage and risk.
6. Use stop-loss orders to limit your losses
Stop-loss orders are designed to limit an investor’s losses by automatically selling a cryptocurrency when it drops below a certain price. For example, if you own Bitcoin and you set a stop-loss order at $18,000, your position will be sold automatically if the price of Bitcoin falls to $18,000 or lower. With recent fluctuations in the market, the crypto market is in turmoil as many of the crypto coins are at the lowest of the year. Other than slippage, stop loss also helps to avoid bigger losses as in the current situation.
While stop-loss orders can help to limit your losses, they also come with some risks. If the market suddenly becomes very volatile, your stop-loss order may be triggered prematurely, resulting in a larger loss than you had anticipated.
Additionally, if the market is illiquid at the time your stop-loss order is triggered, you may experience slippage and sell your cryptocurrency at a much lower price than you had anticipated. Overall, stop-loss orders can be a helpful tool for managing risk in the cryptocurrency market, but it is important to understand the potential disadvantages before using them.
Example of slippage
Slippage can be understood by this example. For example, if you were buying Bitcoin when the price was $20,000 but the price fell to $19,000 by the time your trade was executed, you would have experienced a slippage of 10%.
Slippage can also occur when selling a currency; if the price falls after you initiate a sell order but before it is executed, you will receive less than you intended for your sale.
How to calculate slippage
Slippage is calculated by taking the difference between the price you intended to buy or sell at, and the price you actually bought or sold at. This difference is then divided by the original price, and multiplied by 100 to get a percentage.
For example, if you wanted to buy Bitcoin at $20,000 but it ended up costing you $19,000, the calculation would look like this:
(19,000 – 20,000) / 20,000 * 100 = -5%
Similarly, if you wanted to sell Bitcoin at $19,500 but it only sold for $19,300, the calculation would be:
(19,500 – 19,300) / 19,500 * 100 = -1%
In both cases, the slippage is negative because you paid more (or received less) than you intended. A positive slippage would occur if you buy Bitcoin at $20,200 (2% higher than intended) or sold it at $19,700 (1.5% higher than intended).
Difference between Positive vs. Negative Slippage
Positive slippage occurs when you buy or sell a security for a better-than-expected price. In our Bitcoin example, positive slippage would have occurred if you’d bought the cryptocurrency at $20,200 or sold it at $19,700. Positive slippage is generally seen as a good thing, as it means you’ve made a profit on your trade that you wouldn’t have otherwise made.
Negative slippage, on the other hand, is when you buy or sell a security for a worse-than-expected price. In our Bitcoin example, negative slippage would have occurred if you’d bought the cryptocurrency at $19,000 or sold it at $19,300. Negative slippage can obviously eat into your profits and is something you’ll want to avoid if possible.
Why is Slippage Common in Crypto?
Slippage is common in the cryptocurrency market for a few reasons. First, the market is still relatively new and immature compared to other asset classes. This lack of maturity means there is often less liquidity in the market, which can lead to more pronounced price movements and a greater chance of slippage. Additionally, cryptocurrency exchanges often have lower limits on the amount of money you can trade at once, which can also lead to more pronounced price movements and greater chances of slippage.
What is Slippage Tolerance?
Slippage tolerance is the maximum amount of slippage you are willing to accept on a trade. For example, if you are buying Bitcoin and are willing to accept a maximum slippage of 2%, that means you are okay with the price moving up or down 2% from the price you intended to buy at. If the price moves more than 2% in either direction, you will not make the trade.
Ways to calculate slippage tolerance for your own investments
There is no hard and fast rule for how to calculate slippage tolerance, as it will vary depending on your investment goals and risk tolerance. A good starting point is to look at the average daily price movement of the asset you are interested in trading.
If the asset typically moves 2% per day, a slippage tolerance of 2% would likely be too high, as there is a good chance you will experience slippage on at least some of your trades.
Conversely, if the asset typically only moves 0.2% per day, a 2% slippage tolerance may be too low, as it would be very difficult to find a trade that meets your criteria.