In the world of decentralized finance (DeFi), one term that is often encountered but might not be fully understood is "slippage." While this phenomenon is not exclusive to decentralized platforms, understanding how it operates within this context is crucial. Let's dive into what slippage is, how it works in Decentralized Exchanges (DEX), and why using a DEX aggregator like Slingshot can provide a distinct advantage.
What is Slippage?
Slippage is the difference between the expected price of a swap and the actual price at which the swap executes. This difference occurs due to fluctuations in supply and demand and is a natural occurrence in both centralized and decentralized marketplaces. In the context of DEXes, slippage is often associated with liquidity levels and can vary dramatically depending on the asset being swapped and the size of the order.
Clarification: 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
If you're swapping 2 ETH for WBTC and the quoted rate is 0.1259 WBTC, your final amount will be that rate plus or minus the slippage tolerance you set (for example, 1%). This tolerance range allows the transaction to fail if market volatility causes the slippage to exceed the set boundaries.
This means that once you confirm the swap, you will receive at least 0.124641 WBTC and at most 0.127159 WBTC, which is plus or minus 1% from the quoted 0.1259 WBTC. If the market price of ETH/WBTC suddenly moves and leads to you receiving less than 0.124641 WBTC or more than 0.127159 WBTC, your swap will fail.
Alternatively, if you set your slippage tolerance to 0%, you must receive the exact 0.1259 WBTC you were quoted. If the liquidity pools cannot ensure that, then the swap will fail.
❗ Be aware of the slippage setting you are currently using before placing a swap ❗
Why Does Slippage Happen?
In a DEX, assets are swapped directly from liquidity pools rather than being matched with other orders. If a liquidity pool does not have enough of an asset to fulfill a large order, it will cause the final price to shift unfavorably for the swapper, resulting in slippage. The amount of slippage you encounter will depend on:
Order Size: Larger orders relative to the pool size will likely lead to higher slippage.
Liquidity: A well-funded liquidity pool will reduce the chance and amount of slippage.
Market Conditions: During volatile times, rapid price changes can increase slippage.
The Limitations of Single DEX Platforms
Even the most popular DEX platforms like Uniswap or Sushiswap can suffer from slippage. These platforms 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’s DEX Aggregator Can Help
Slingshot operates as a DEX aggregator, sourcing liquidity from various decentralized exchanges. Here’s how that can benefit you:
Broad Liquidity: By pooling resources from multiple exchanges, Slingshot can offer better liquidity, drastically reducing the chances of slippage.
Best Prices: Slingshot scans various DEXs to offer you the best trading price, potentially saving you money even when accounting for fees. We route your order through multiple DEXes, if needed. For example, you may end up using Uniswap, Sushiswap, and 0x in a single transaction
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.
Risk Mitigation: With more comprehensive data, Slingshot can help mitigate the risks associated with slippage by utilizing features like slippage protection and smart order routing.
Positive Slippage: Sometimes, slippage can result in a better price than what was originally quoted. Unlike some other DEX aggregators, Slingshot lets users keep all positive slippage.
Why would a user want to increase slippage?
Main reason will be that the user wants to swap a very illiquid token, meaning that even a small transaction may drastically increase its price, so with a low slippage setting, your transaction will fail. This is not recommended to do, but many users like to swap illiquid tokens for different reasons.
Conclusion
Slippage is a common issue that needs to be navigated in the world of decentralized finance. While individual DEX platforms offer some level of protection, they are often limited by their liquidity pools and range of assets. DEX aggregators like Slingshot offer a compelling solution by pooling liquidity and scanning multiple platforms, thereby reducing slippage and offering the best possible trading conditions.