Spread and Slippage: Closely Affect Your Trading Costs

Understanding Market Microstructure

In cryptocurrency trading, every transaction doesn’t happen out of thin air. There is always some tension between the price buyers want and the price sellers are willing to accept. This tension is the root of the bid-ask spread. Simply put, the bid-ask spread refers to the difference between the highest bid and the lowest ask in the order book.

When you execute a market order immediately, you can’t always get the ideal price. Behind this are three key factors: market depth, trading volume, and asset volatility. Understanding how these factors interact is crucial to avoiding unexpected costs.

Liquidity: The Key to Determining Spread Width

Not all assets have the same bid-ask spread. It depends on the level of liquidity.

High-liquidity assets (like Bitcoin) have extremely narrow price gaps. This is because a large number of buy and sell orders are queued in the order book, allowing market participants to trade relatively easily without causing drastic price fluctuations. In contrast, lower-volume tokens face wider spreads.

For example: When this article was written, BIFI had a sell-side quote of $907 and a buy-side quote of $901, with a spread of $6. Calculating the spread percentage: (907-901)/907 × 100 ≈ 0.66%. Bitcoin’s spread is only 0.0083%. Although the absolute numbers may be similar, the percentage difference is huge. This clearly shows that BIFI’s liquidity is far lower than Bitcoin’s.

How Market Makers Profit from the Spread

Liquidity doesn’t appear out of nowhere. In traditional financial markets, market makers and brokers provide liquidity. The situation is similar in crypto markets but with some differences.

Market makers profit by repeatedly executing the same operation: creating arbitrage profits through buy low, sell high. Suppose a market maker places a bid at $350 to buy BNB and an ask at $351 to sell BNB. The $1 difference is their arbitrage profit. Although the profit per trade is small, high-frequency trading can accumulate significant gains. Due to fierce competition, the spreads of high-demand assets are often driven down by market maker competition.

Order Book Depth Analysis

To intuitively understand the bid-ask spread, you can look at the order book depth chart on the trading platform. This chart shows buy orders in green and sell orders in red. The gap between them is the additional cost you need to pay.

The deeper the order book (i.e., the larger the order volume at a specific price level), the smaller the spread. This reflects the inverse relationship between liquidity and spread—the higher the trading volume, the lower the spread as a percentage of the asset price.

Slippage: Hidden Cost in Market Execution

Now, let’s turn to another key concept: slippage. Slippage refers to the difference between the actual transaction price and the expected price. This often occurs in volatile or low-liquidity environments.

Suppose you place a market order to buy an asset at $100, but the available liquidity in the order book isn’t enough to fill your order at that price. The system automatically searches for higher price levels to fulfill your order, and the final transaction price might be $105 or higher. This is negative slippage.

In volatile assets or small tokens with low liquidity, slippage can exceed 10%. For automated market makers (AMMs) and decentralized exchanges, slippage is a common phenomenon.

Positive Slippage and Risk Management

It’s worth noting that slippage isn’t always unfavorable. In highly volatile markets, sometimes the selling price rises while selling orders are executed, or the buying price drops when buying, which is positive slippage. However, this situation is rare.

Many trading platforms allow you to set slippage tolerance. You can specify the maximum acceptable slippage percentage; if the slippage exceeds this threshold, the order won’t be executed. This provides protection but at the cost of potential order non-execution or being front-run by other traders or bots with higher gas fees (especially common on decentralized exchanges).

Practical Strategies: Minimizing Costs

While it’s impossible to completely avoid slippage, several strategies can help reduce its negative impact:

First: Break Large Orders

Instead of submitting a large order all at once, split it into multiple smaller orders. Monitor the available liquidity in the order book carefully to ensure each order’s size doesn’t exceed the available volume at that price level. This helps reduce price impact.

Second: Consider Trading Costs

When trading on decentralized exchanges, don’t forget network fees. During certain periods, gas fees can be extremely high, offsetting the savings from cautious trading. Weighing costs against benefits requires real-time assessment.

Third: Be Aware of Risks in Small Liquidity Pools

Interacting with small liquidity pools, even if individual trades seem manageable, can cumulatively impact prices through multiple transactions. Subsequent trades may execute at worse prices.

Fourth: Use Limit Orders

Limit orders guarantee you get your desired price or better. Although they are not as fast as market orders and don’t guarantee execution, they can completely avoid negative slippage risks. Especially recommended for large trades.

Final Reminder

When trading crypto assets, the bid-ask spread and slippage are unavoidable realities. While these costs may have minimal impact on small trades, large orders can be executed at prices far above expectations. For traders exploring decentralized finance, mastering these fundamentals and developing corresponding strategies are essential to prevent capital losses. Lack of this knowledge can come at a cost, whether through front-running or excessive slippage.