What Is “Slippage” and How Does It Affect Arbitrage Trading in a Pool?
Slippage is the difference between the expected price of a trade and the executed price. In a liquidity pool, large trades cause high slippage because they significantly alter the ratio of tokens, moving the price along the bonding curve.
Arbitrageurs must factor in slippage, as it reduces their profit margin and limits the size of the trade they can profitably execute before the pool's price aligns with the external market.
Glossar
Liquidity Pools
Provision ⎊ Liquidity Pools are smart contracts holding reserves of two or more assets, facilitating automated trading via an algorithmic pricing mechanism rather than a traditional order book, and are the backbone of decentralized exchange functionality.
Profit Margin
Yield ⎊ Profit margin within cryptocurrency, options, and derivatives contexts represents the net profit realized as a percentage of the invested capital, factoring in transaction costs and risk-adjusted returns.
Expected Price
Price ⎊ Within cryptocurrency derivatives, options trading, and financial engineering, price represents the prevailing market valuation of an underlying asset, reflecting a complex interplay of supply, demand, and anticipated future performance.
Maximum Slippage Tolerance
Tolerance ⎊ Maximum Slippage Tolerance, within cryptocurrency, options trading, and financial derivatives, defines the acceptable deviation between the expected price of a trade and the price at which the trade is actually executed.
Arbitrage Trading
Exploitation ⎊ The core of arbitrage trading within cryptocurrency, options, and derivatives involves identifying and profiting from temporary price discrepancies across different markets or exchanges.
Large Trades
Execution ⎊ Large trades, within cryptocurrency and derivatives markets, represent order flow significantly impacting short-term liquidity and price discovery, often originating from institutional investors or high-frequency trading firms.