What is Price Slippage? (And why should you care?)

“Price slippage” in crypto trading (or any trading) is the difference between the price you expect and the price you get. It occurs in both legacy trading systems and modern trading systems like most of DeFi.  

Of course, you might know that part and be wondering why it happens. Let’s find out. 

Where does slippage come from? 

Most traditional exchanges are set up with the idea that you get the most favorable price available when executing an order–so ostensibly, you should get the lowest purchase price available if buying and the highest sales price available if selling. 

So, you’ll get quoted a price and if you’re like most traders you expect that to be the price you actually get. In fact, you’re likely to get a slightly different price if markets are fairly stable and liquid. If markets are very volatile or thinly traded (…or if you’re trading crypto), you could get a wildly different price. 

In either case, that difference is called slippage. Most of the time, we’re not bent out of shape about getting “good” slippage–meaning the price moves in your favor. As such, we’re going to go ahead and assume that we’re talking about “bad” slippage from here on out. 

Why slippage occurs (general reasons) 

There are a few general reasons–in both TradFi and crypto markets–that price slippage might occur. 

• Price volatility: If prices are moving as you execute an order, your execution price will likely move, too. Highly volatile markets beget more slippage than stable markets. 
• Low liquidity: If there isn’t enough inventory at the price you want, you might need to adjust the price to fill your order. This generally applies to very large orders or thinly-traded markets–the definitions of both will be highly dependent on context. 
• Market gaps: This applies to markets that are either under centralized control or which aren’t open 24 hours a day–if there’s a break because markets have closed or because of a trading halt, you could see slippage on an open order. 

These are some of the most basic market mechanics behind price slippage. You could of course make the argument that market centralization/closures can make slippage worse (in fact the latter is quite an interesting intellectual rabbithole in itself), but we’re not going there in this article.

In crypto, when you hear people talk about slippage, they’re attributing it to volatility and liquidity. In boom/bust cycles, prices can move widely very fast, which means they’re also moving a lot while your trade executes. Similarly, liquidity in crypto is broadly much lower than that in TradFi. With a lower overall level of “supply,” any change in demand can have an outsize impact on price. 

However, this problem is much greater than the simple mechanics described here.  

Why slippage occurs (manipulative reasons)

Aside from basic market mechanics, you could have more manipulative causes of price slippage, like front-running and reordering attacks. These factors are well-known issues in both traditional finance and DeFi, but price slippage is an externality of both of them that isn’t often discussed. We want to take the chance to discuss it here. 

First, some definitions.  

Front-running occurs in both TradFi and in crypto markets. At its most basic, front-running is the act of seeing what orders are coming in and adjusting your own trade decisions ahead of them; basically, you can see what’ll happen to prices based on order flow and position yourself to profit from it. 

This isn’t based on being more astute at market observation or better at math: It’s based entirely on having early access to information. 

For example, a frontrunner might see that prices are going to go up based on order flow, so they buy out all resting inventory and sell to those incoming orders at a higher price. If you were on the other side of that trade, you probably expected to buy at the previous market price and found yourself buying at the new one. 

This applies to both traditional finance and DeFi. Robin Hood got into trouble for this with payment for order flow to Citadel; in DeFi, it’s orders of magnitude more significant due to the role of the mem pool in transaction ordering.

Similarly, there’s reordering. This is pretty unique to DeFi because of the mechanics of DeFi trading. Similarly to front-running, these types of attacks are carried out when transactions go through the memory pool–the costs are seen as MEV. 

According to Flashbots (and as of this writing), about $675 million has been lost to MEV so far–we would argue that the true cost is higher, and we’re working on research to find out whether we’re right about that. 

The impact of manipulative practices on prices

These are individual problems on their own, but they can also cause price slippage, which is why we’re talking about them here. Here’s how it works. 

If you’ve ever placed a trade in DeFi, you’ve probably set a slippage tolerance–this is how much you’re willing to let the price move without canceling the order. Say you set a slippage tolerance of 200 basis points (that’s 2%) on a trade.

Someone who wants to front-run one or more trades faces a trade-off between the potential gains they can make with the cost they have to pay (gas and protocol fees). For any given fee structure, the higher your slippage tolerance, the higher their potential profit. 

Sidebar: We think this problem is going to get more significant as DeFi moves to more scalable systems. That’s because scalability means costs go down, which means that incrementally smaller trades become profitable to front-run. 

In other words, the lower the costs your frontrunner faces, the bigger the universe of profitable trades there are to front-run. 

Why should you care? 

Price slippage due to market mechanics sucks, but price slippage due to manipulation means you’re being taken for a ride. 

Basically, in a situation like this, a couple of actors (like Citadel in TradFi or MEV bots in DeFi) are skimming risk-free gains at the expense of every other market participant. You might not notice the costs you’re paying due to price slippage on small trades. But you are paying.  

We think slippage due to manipulative practices is bad for market efficiency, it’s bad for fairness, and it’s bad for the future of DeFi. It is simply dead weight on the functioning of fair markets. And it’s a significant reason why DeFi isn’t growing.  

That’s where Krypton comes from 

Michael, our co-founder, used to be a quant in the traditional asset management industry, and he tells the story of how surprised he was at how much time his company spent assessing transaction efficiency. The question was, “Based on the potential for slippage and other inefficiencies, should we even execute this trade we want?”  

Just ponder that for a second. Even in a regulated, highly liquid, peer-to-peer trading space like TradFi public equities, institutions are paying PhDs to figure out whether it’s too cost inefficient to even put on a trade. Retail traders almost don’t stand a chance–and that’s why we invented Krypton.

With Krypton, instead of trading in a lump sum that can move the market against you, we execute your trade in tiny increments over a period of time. The parameters of your trade are placed in a smart contract, and nothing is committed to the blockchain until settlement. These two features accomplish two important things: a) because your order is sliced up into a flow of tiny orders, it’s impossible to make money by front-running you, and b) because everything is committed to the smart contract first you’re protected from price slippage due to reordering and other market problems, like arbitrage. 

There’s a lot to talk about on all these fronts, but in the meantime: What did you think of this article? Did anything surprise you about what we’ve shared, and are there any questions in your mind about this subject that we can answer? 

Please share in the comments!