Digital currencies continue to expand an emerging new digital asset class. And similar to any new asset class, price volatility remains a crucial consideration. As we’ve seen very recently, the price of Bitcoin can vary dramatically over the course of a day, a minute or even a few seconds. But with a constantly fluctuating price, how do you avoid slips in value during the exchange process? Whether you’re buying a digital asset, or selling to fatten your bank account with HODL profits, you’ll want to avoid the potential for slippage.
What Is Slippage?
To put it simply, slippage occurs when the expected price for your trade turns out to be different from when the trade is actually executed - whether positive or negative. It occurs in all market venues, including equities, bonds, futures and fiat currencies. It is most prominent when executing a larger order, a market-priced order, or when there is price volatility in the market.
For example, perhaps you want to buy some bitcoin (BTC), so you start by investing $1,000 USD:
- If BTC is trading at $7,988.97, your $1,000 will exchange for 0.1251 BTC.
- Now assume during this trade that the price of BTC increases by 2.7% and is now worth $8,204.67 for 1 BTC, translating to 0.1218 BTC.
- Because your $1,000 buys less BTC than originally indicated, you’ve experienced price slippage during the trade.
How Does Slippage Occur?
There are a few different forms of slippage. One form occurs when placing a market order for a digital currency on a crypto exchange such as Binance or Coinsquare. Market orders are placed on the market to execute when the best available price is found, but the trading price is not guaranteed. Due to price volatility, the asset can either increase or decrease in value during the trade, and the market order will automatically execute at the best available price. You will be left with either more or less of your initial value than expected.
When making high-value trades on an exchange, greater than $100K for example, the trade will almost certainly be broken up into smaller chunks. Once broken up, each trade will end up being priced differently. Prices quoted on exchanges represent the last price the currency was bought for, which can be misleading because not everyone on the exchange will want to trade for that same price. After a certain number of trades, there will no longer be sellers at your proposed price, and your trade will slip further from the market rate.
Another way large trades could incur slippage is by negatively impacting the limited market of the exchange. The more an asset is sold, the more the price falls. Because a large trade will influence exchange prices, the larger your order, the more slippage will occur. The chart below shows how slippage increases as the trade amount increases.
How to Avoid Slippage
One way to avoid slippage is by using a limit price order instead of a market price order. With a limit order, you set either the maximum buy limit or minimum sell limit for your order. This order will not be executed until those price conditions are met. Although you may avoid slippage, volatile prices can leave little time for your trade to execute.
Over-the-Counter Desks (OTC)
The best way to avoid slippage, particularly for a large trading order, is to use an OTC desk. OTC desks enable you to find a fixed price for a single buy or sell order. Because the transaction is not done through an exchange, it does not affect the market for your trade. OTC desks find buyers and sellers looking to trade and set them up directly. As an intermediary, they may or may not take on the risk of the trade directly. This arrangement depends on if they are a principal OTC or an agency OTC. With a set price agreed upon by the seller and buyer, the risk of slippage is averted.
Whether you’re new to digital assets or an experienced crypto trader, it’s important to understand slippage in order to keep the value of your assets intact when trading. You can use limited price orders and OTC desks, particularly when trading larger sums, to mitigate your risk and the impact of slippage.
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