In decentralized finance (DeFi), the term "slippage" is often encountered but might not be fully understood. Let's dive into what slippage is, how it works in the context of decentralized exchanges (DEXs), and why using Slingshot offers more protection against it.
What is Slippage?
Slippage is the difference between the expected and the actual price at which a trade executes. This difference occurs due to fluctuations in supply and demand and is a natural occurrence in both centralized and decentralized markets.
In the context of DEXs, slippage is influenced by token liquidity levels and trade sizes.
Slippage is measured between the two tokens you are swapping, not their USD value. This is a common misconception, particularly for those new to crypto trading.
Slippage and Quotes
Slippage tolerance dictates the maximum deviation from the quoted price you are willing to accept. The transaction will fail if market volatility causes slippage to exceed the set boundaries.
For example, if you swap 1 ETH for USDC with a quoted rate of 4000 USDC and slippage tolerance of 1%, you will receive 4000 USDC plus or minus 1%, which is at least 3,960 USDC and at most 4,040 USDC. If the market price of ETH/USDC suddenly moves significantly enough leading you to receive an amount outside that range, the trade will fail.
The ideal slippage setting varies depending on the token and transaction. If slippage tolerance is too low, the transaction has a higher likelihood to fail with even normal price movements. At the extreme, if slippage tolerance is set to 0%, you must receive exactly 4,000 USDC as quoted. If the liquidity pools cannot ensure that, the trade will fail.
If slippage tolerance is set too high, the transaction is more likely to complete however you risk a negative price impact. Attackers may front-run your transaction to extract the difference in value for themselves.
❗ Be aware of the slippage setting you are using before placing a swap ❗
Why Does Slippage Happen?
In a DEX, trades execute using algorithmically-governed liquidity pools rather than being matched with other orders as in a central limit order book. Mathematical formulas determine token prices based on the ratio of tokens in the liquidity pool. Slippage depends on:
Liquidity: If a liquidity pool does not have enough of an asset, smaller trades can cause significant price movement. A well-funded liquidity pool experiences less price movement, and therefore slippage
Order Size: Large orders relative to the pool size have greater impact on market price
Market Conditions: During market volatility, rapid price changes can occur between when an order is placed and when it is executed
The Limitations of Single DEX Apps
Even the most popular DEX apps like Uniswap or Sushiswap can suffer from slippage. These apps often focus on specific sets of assets, limiting their liquidity pools. If you're looking to swap a less popular or new asset, you might find yourself dealing with high slippage.
How Slingshot Can Help
Slingshot is powered by DEX aggregators, sourcing liquidity from multiple DEXs. Here’s how that can benefit you:
Broad Liquidity: By pooling resources from multiple exchanges, DEX aggregators offer better liquidity, reducing the chances of slippage. For tokens with multiple pools on multiple DEXes, Slingshot finds the best quote across all of them.
Best Prices: DEX aggregators find trade routes across DEXs for the best trading price and least slippage, routing through multiple DEXs if needed. For example, you may end up using Uniswap, Sushiswap, and Balancer0x together to optimize your trade.
Reduced Complexity: You don't need to manage multiple DEX interfaces or keep tabs on which DEX has the best rate for a specific asset; Slingshot does all this for you.
Slingshot Auto Slippage Feature
Slingshot's auto slippage feature estimates the slippage tolerance to optimize for price impact and transaction success. You may still want to manually adjust slippage for certain transactions.
Auto slippage is currently live on Solana. Slippage on other chains is set to a default of 3% and can be adjusted.
You may want to change the default slippage for certain trades, such as when swapping very illiquid tokens. Since even a small transaction can significantly impact the price of such tokens, trades are more likely to fail on a slippage setting that is too low. While increasing slippage can help in these cases, using a high slippage setting is not generally recommended unless you understand the risks involved.