Slippage and price impact are two very important concepts in DeFi, but are often misunderstood and confused with each other due to their similar effects in terms of losses.
What Is Slippage?
Slippage is the concept of being affected by the difference in price, between the point at which you send your transaction and the moment it gets mined (completed). As an example, imagine swapping your ETH for SUSHI in an attempt to exit an ETH dump and enter a SUSHI pump. However, while waiting for your transaction to get mined, the price of ETH drops by 1%, while SUSHI went up by 1%: this would incur a 2% slippage. If you had set your slippage below this amount, the swap would fail!
It's useful to think of setting slippage percentages like this: you are effectively inputting a minimum quantity of tokens you will receive from the swap.
What Is Price Impact?
Price Impact is affected by the size of your trade relative to the available liquidity within the pool. It is a function of the constant product formula, which is defined as: x∗y=kx∗y=k.
In a traditional order-book model, you might have an asset that trades at $10. However, if a buyer with a large enough order comes around, he/she may take up all the offers to buy the asset at $10, $11 & $12. This will cause the average buying price on that asset to fall somewhere in between the range of $10 to $12 for that particular individual.
With an AMM (Automated Market Maker), the value of an asset is directly related to the balance of tokens in the pool. This balance is shifted during the swap, thus the final execution price will always fall somewhere in between.
A general rule to remember is that price impact will be around twice the size of your order relative to the size of the pool.
Why Are These Important?
Slippage and price impact are both very important concepts to understand, as they should both be considered whenever making a financial decision on-chain. Sushi's pools are permission-less, and therefore can have negative slippage and price impact effects that a user can still follow through on if they are unaware. Always check for any warnings on the interface and set a maximum slippage percentage to protect yourself.
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