Slippage happens when there is a difference between the price the investor is expecting to pay in a trade, and the actual price the trade is executed.
It occurs both in traditional markets and in the crypto markets, whenever investors use market orders to buy or sell assets.
But despite being an everyday phenomenon for new and experienced investors alike, “slippage” is a word that few investors understand.
For crypto investors, understanding slippage goes beyond a simple definition. Slippage plays a key role in trading assets on both centralised exchanges (CEX) and decentralised exchanges (DEX), particularly with new and smaller tokens .
Knowing the difference between slippage in the stock and crypto markets can help investors plan their trades and investments without surprises while also keeping them informed on the best way to support their favourite projects.
We'll cover all you need to know about slippage in this article, including:
- Common definition
- What is slippage in crypto
- Why it matters
- How investors should manage slippage
- How Phuture minimises slippage to improve user investments
Let's dive in.
What is slippage?
Slippage is when someone else’s order is executed before yours, and therefore the market moves before you complete your transaction. This happens in both traditional markets and in crypto.
An investor looking at recent trades notices that a certain asset is trading at or around a particular price. They place an order for that asset. The order is executed, but sometimes the price they receive is different from the one they expected.
In the time it took for the order to execute, the market shifted, so the price ‘slipped’.
Slippage in traditional markets
Slippage occurs in all of the traditional investment markets - stocks, bonds, equities, etc. The mechanisms by which slippage occurs are largely the same across those markets: it’s caused by the market shifting between the time the order was sent, and the moment the trade was executed.
Slippage in crypto markets
How it occurs
Slippage in crypto is the act of someone else's order having a higher priority in the block than yours, causing their trade to execute first, and therefore shifting your final price from what you were quoted.
Slippage can either be benign or intentional. Benign slippage occurs when another trader serendipitously gets ahead of you in the block with no mal intent. Intentional slippage occurs when your trade is targeted by arbitrageurs so that they can profit from your order.
Why is slippage more common in crypto?
Crypto markets can be more prone to slippage than stocks for two very important reasons:
- Higher volatility
- Lower liquidity
- How trades are executed
Higher volatility and lower liquidity means it takes a smaller dollar-value to move the prices of the assets. Therefore, orders executed in volatile markets are more susceptible to market movements before your order is executed.
Furthermore, the majority of trades executed in crypto are done so through market orders with very little trade flow settling via limit orders. Unlike limit orders, market orders are affected by changes in the market price.
Because of that, crypto traders are more likely to encounter price slippage.
Is slippage always negative for the user?
No, traders can experience both positive and negative slippage. Slippage is just the difference between the expected price and the realised price, but that difference could be good or bad depending on which way the market was going.
- Negative slippage occurs whenever you receive less of the desired asset than expected. Example: if you’re trading USDC for ETH, negative slippage would be receiving less ETH than expected.
- When the opposite happens, that’s positive slippage. Example: if you’re trading USDC for ETH, positive slippage would result in receiving more ETH than expected.
Why is slippage important?
Slippage is important because it affects each and every single trades, from small to large.
And if your trades constantly suffer from negative slippage, it essentially damages the performance of your investments.
This impacts investors from all sizes, but even more so investors deploying large amounts of capital. Just a small negative slippage can cost you a large dollar amount in investment performance.
Volatility: how does it affect slippage?
The greater the swings between high and low prices, the greater the volatility of an asset. And the greater the volatility, the more likely it is that slippage will occur on any trade.
As a young market, crypto is especially volatile, making it even more prone to the phenomenon than traditional markets.
Assets with larger market capitalisation tend to have lower volatility than lower capitalised tokens.
Liquidity: how does it affect slippage?
In general, high liquidity decreases slippage while low liquidity increases it.
That’s because in a lower liquidity market, it takes a lot less capital to move the market and therefore it is easier for other people’s trades to affect yours.
Managing slippage as part of an investment strategy
Using limit orders rather than market orders can reduce or eliminate slippage. Limit orders are agreements to buy or sell assets only at a set price, rather than taking advantage of the market.
Some exchanges, often decentralised exchanges (DEX), allow investors to set a slippage tolerance. The slippage tolerance is a percentage that limits the difference between the original price of order and the final price. Set the slippage tolerance at 1%, and any difference greater than that will stop the trade from executing.
What is a good slippage tolerance? A narrower tolerance reduces slippage, but at the cost of missing trading opportunities. A very narrow tolerance starts to look like a limit order, and comes with the same downsides.
How does Phuture reduce slippage for investors?
We want to constantly offer the best experience for our users, and managing slippage is a key part of the investment journey.
With PDI, our first index, there are some intrinsic aspects that protect Phuture investors from slippage:
- We ensure PDI has deep liquidity
- The tokens within PDI are the largest assets in DeFi by market cap, which means they are less susceptible to volatility and thus slippage
- Our PDI methodology also specifies that each token must have a minimum of $5 million in on-chain liquidity, which also minimises slippage.
Apart from our product structure, we also work with partners to improve the architecture. This is where 0x comes into play.
Phuture and 0x
0x API offers liquidity aggregation and smart order routing as-a-service. It works as a connectivity layer that powers any project looking to integrate DEXs and source multi-chain liquidity across 100+ decentralised sources.
We’ve recently integrated the 0x API to tap into liquidity across all major exchanges, as well as their slippage protection feature. 0x now powers all entries, exits and rebalancing events at Phuture, which reduces slippage and in turn improves index performance for all our users. - Oliver Mehr, cofounder and Head of Product at Phuture
How 0x reduces slippage for Phuture investors:
- All transactions related to PDI are routed through 0x. This means all swaps, redemptions, mints, as well as our index rebalancing run through the 0x API. This ensures we’re capturing the best liquidity, which intrinsically minimises slippage.
- On top of that, 0x has a slippage protection feature, which smartly routes all Phuture transactions listed above to minimise slippage as much as possible.
- 0x and its slippage protection feature also powers our rebalancing events, which in turn improves index performance.
In a nutshell, the 0x integration and its slippage protection feature optimises our users' funds from all sides. Learn more about our partnership here.
Phuture offers investors a simple way to invest in crypto index funds. Our first index, Phuture DeFi Index (PDI) gives you exposure to the top assets in DeFi while also capturing additional returns from yield-generating protocols.