Bid-Ask Spread and Slippage in Cryptocurrency Trading

In our previous lesson, we covered market capitalization, a crucial metric for understanding the cryptocurrency market. Now, we turn our attention to bid-ask spread and slippage, two important concepts that impact trade execution. This lesson also explores the roles of market makers and market takers in shaping these trading dynamics.

Contents

• What is a Bid-Ask Spread?
• What is Slippage?
• Types of Slippage

What is a Bid-Ask Spread?

To grasp the bid-ask spread, it's essential to understand the two main participants in financial markets: market makers and market takers.
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• Market makers set prices at which they are willing to buy or sell an asset. They establish two key price points:
  
  • Ask price – the lowest price at which they are willing to sell the asset.
  • Bid price – the highest price at which they are willing to buy the asset.
• Market takers accept these prices to execute a trade. They buy at the ask price and sell at the bid price.

The bid-ask spread represents the difference between the highest price a buyer is willing to pay (bid price) and the lowest price a seller is willing to accept (ask price). In cryptocurrency markets, this spread is determined by the gap between limit orders placed by buyers and sellers.

The bid-ask spread percentage is calculated using the following formula:
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Bid-Ask Spread Percentage = (Ask Price − Bid Price) / Ask Price​ × 100%
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This formula expresses the spread as a percentage of the ask price, helping traders compare spreads across different assets.
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If you want to purchase an asset immediately, you must accept the lowest ask price available. Conversely, if you need to sell quickly, you must take the highest bid price offered.

Factors Affecting the Bid-Ask Spread

The spread is influenced by several factors, but liquidity plays a key role.
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• High liquidity – Assets with a high trading volume (such as Bitcoin and Ethereum) tend to have a low bid-ask spread, making them easier to trade.
• Low liquidity – Less popular cryptocurrencies with low trading volume tend to have a wider bid-ask spread.

What is Slippage?

Traders expect their orders to execute at the exact price they select, but this is not always the case. Slippage happens when the final execution price differs from the originally intended price due to price movements between order placement and execution.
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While slippage occurs in all financial markets, it is especially common in cryptocurrency trading, particularly on decentralized exchanges (DEXs), due to high price volatility and lower liquidity.

Causes of Slippage

• Market volatility – Prices fluctuate rapidly, causing execution prices to shift.
• Low liquidity – Some cryptocurrencies, especially altcoins, have low trading volume, making it difficult to match large orders at fixed prices.

One way to reduce slippage is to split large trades into smaller orders.

Types of Slippage

Slippage can be positive or negative, depending on whether the execution price is better or worse than expected.
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• Positive Slippage – Occurs when a buy order is executed at a price lower than the original ask price, benefiting the buyer. For sell orders, it means receiving a higher price than expected.
• Negative Slippage – Occurs when a buy order is executed at a higher price than expected or a sell order at a lower price, resulting in a less favorable outcome for the trader.

Excessive slippage can lead to higher trading costs. To minimize its impact, traders can place limit orders instead of market orders, ensuring their trades execute at predetermined prices. We will explore limit orders in more detail in future lessons.

Conclusion

Bid-ask spread and slippage are essential concepts for understanding trade execution and market liquidity. A smaller spread indicates a liquid market, while a larger spread suggests higher trading costs. Slippage, on the other hand, can impact the final price of a trade, and understanding how to mitigate it can help traders execute more efficient transactions.

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