DeFi, the phenomenon of slippage
In the world of cryptocurrencies, especially within the realm of DeFi, the phenomenon of slippage, referring to price deviations, is prevalent. Today, let’s delve into the concept of slippage and explore its implications. While the most notable innovation in decentralized finance (DeFi) is believed to be the provision of liquidity in decentralized exchanges, it’s crucial to understand the profound relationship between liquidity supply and slippage.
Slippage occurs on decentralized exchanges (DEXs) due to their structural framework and the inherent nature of decentralized trading. Slippage represents the disparity between the anticipated price and the actual executed price in buying and selling transactions. Particularly, it signifies that a trade is executed at a less favorable price than initially projected. The reasons behind slippage on DEXs are as follows:
１．Limited Liquidity on DEXs
DEXs facilitate trades through a technique known as liquidity pools. Within these liquidity pools, an Automated Market Making Algorithm is utilized to determine prices based on token ratios. This algorithm calculates prices based on token supply and demand, thereby automatically setting exchange rates between tokens.
This adaptability to real-time price fluctuations is achieved as trades take place and alter the ratio. Consequently, token prices undergo fluctuations. Thus, there can be differences in prices between the initiation of a trade and its execution.
２．Constrained Liquidity on DEXs
In comparison to centralized exchanges, DEXs often contend with constrained liquidity. When substantial trade volume is initiated, the scarcity of liquidity can lead to disproportionate effects on token prices. This results in a divergence between the anticipated and actual prices, giving rise to slippage.
３．Distinct Token Pair Liquidity
The liquidity of specific token pairs can greatly vary. Pairs with lower liquidity are prone to causing disproportionate impacts on prices due to limited liquidity, consequently heightening the susceptibility to slippage.
４．Incomplete Information
DEXs often encounter limitations in order book information when compared to centralized exchanges. The absence of comprehensive order book data makes it challenging to predict market prices accurately, potentially leading to deviations in executed prices.
５．Front-Running
Within decentralized environments, traders with quicker blockchain transaction access may preemptively predict and execute trades ahead of others. As a result, price fluctuations can emerge between transaction submission and confirmation, contributing to slippage.
The culmination of these factors contributes to the occurrence of slippage on decentralized exchanges. To mitigate slippage, traders should opt for token pairs with higher liquidity and vigilantly monitor prices during trading.
As slippage and liquidity supply are intrinsically linked in the DeFi space, understanding their dynamics becomes instrumental in navigating the intricacies of decentralized financial markets.
