Price slides are a constant risk when trading on Centralized Exchanges (CEXs) and Decentralized Exchanges (DEXs). It occurs when a trader’s order is filled at a price other than the intended price. This can happen due to high volatility, low liquidity or delays in order execution, resulting in a noticeable difference between the expected and actual transaction price.
The DeFi ecosystem prioritizes decentralization and transparency, so the problem of price shifting is more pronounced than on centralized platforms.
Price slide in CEXs and DEXs
In CEXs, price slides are caused by factors such as low liquidity, high volatility and order book depth. CEXs are platforms that connect buyers and sellers of digital assets, with order books being a key element.
An order book is a record of all buy and sell orders placed by traders for a particular cryptocurrency. It shows the quantity and price of each order, and the orders are organized by price. For example, if someone wants to buy $1,000 worth of bitcoin (BTC) and there is another trader who wants to sell their bitcoin for a similar amount, those orders will be matched on the order book. Market orders are filled instantly at the best price, while limit orders are filled on match at a price specified by the trader.
The depth of an order book is defined by the number of buy and sell orders at different price levels. Market depth is a key indicator of liquidity on any platform. So, the greater the depth of market, the less chance there is of a price slide thanks to the balance between buy and sell orders.
In reality, liquidity is not only provided by regular buyers and sellers, but mainly by market makers placing orders on both ends and profiting from the bid-ask spread.
Large CEXs can boast a large amount of liquidity, which minimizes the risk of a price slide since even large orders can be filled.
Since order books are managed by centralized entities, DEXs do not have them at all. Instead, they use the Automated Market Maker (AMM) model, which implies pre-funded pools for each cryptocurrency pair to cover both sides of the trade. The liquidity pools are provided by liquidity providers who are incentivized to lock in an equal value of both cryptocurrencies in a pair. Trading fees on the DEX are distributed to all liquidity providers, who play the role of market makers.
While there are several types of AMM models, the constant product formula is the most common. Because it requires a constant balance between the pair components, a standard AMM is vulnerable to price slides due to the price impact, which can be influenced by the size of the liquidity pool and the order size. When a trader places a buy or sell order, the AMM algorithm calculates the new price based on the change in the ratio of tokens in the pool. Low liquidity can lead to significant slippage as large orders tend to create an imbalance.
Other factors leading to a price slide in AMMs are related to price volatility, maximum extractable value (MEV) on Ethereum, blockchain throughput, front running (prior knowledge), and sandwich attacks, among others.
How to fight price slides in DeFi
Since DEXs are more prone to price slides than CEXs, most of them integrate a feature that allows users to set the slide tolerance percentage to limit the difference between the order price and the execution price. If the final price exceeds the limit, the transaction will be reversed. While this is a useful tool, a low slippage tolerance would cause most large orders to fail, while a higher tolerance can result in an unfavorable trade.
To reduce the risk of price slides, DEXs need to ensure high liquidity in their pools. There is no DEX that can compete with large CEXs in terms of liquidity, but DEX aggregators can do the trick. DEX aggregators ensure a high level of liquidity by being able to access multiple DEXs at the same time. Features like order splitting and order routing can further reduce the risk of price slides.
YetAnotherDeFi (YAD) is a relevant example of a DEX aggregator. YAD is a multichain swap router that aggregates liquidity across six major blockchains including Ethereum, BSC, Polygon, Avalanche, Fantom and Optimism. The platform allows traders to trade over 3,500 tokens at the best rates and with minimal transaction fees.
YAD uses a decentralized and non-custodial swap technology that allows traders to exchange tokens with minimal risk of price slides.
By using YAD, traders can also reduce the risk of front-running, which happens when malicious actors exploit a blockchain’s mempool to gain prior knowledge of trading activity.
Unlike dark pools that split and shuffle large orders, YAD is decentralized and transparent, resulting in unmatched security for traders.
The final result
Price slide is an inevitable factor for DeFi. This is one of the main disadvantages of the AMM model, decentralization and blockchain transparency. Traders should do their due diligence before choosing a DEX and use all available tools to reduce the risk of price slides and associated losses.
DEX aggregators integrate all available tools to reduce negative slippage and allow users to automate the trading process while keeping it transparent, decentralized and secure.
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