Avoid The Pitfalls Of Low Liquidity
Overview
Price impact refers to the change in the market price that is brought about due to the execution of a transaction. Price impact is determined by the trade size relative to the available liquidity. In general, as each token purchased results in less available supply, it follows that the price of each additional token unit increases accordingly. Put simply, the more tokens demanded by a trade, the higher the average price per token as tokens will have to be sourced further and further from the market price (i.e. the market price only indicates the price of the next available token).
As an example, the screenshot above taken from the KyberSwap swap page indicates that a 10M USDC to USDT trade would result in a 14.65% price impact. This means that such a trade would result in the trader paying, on average, 14.65% more USDC per USDT token as compared to the current market price.
As price impact is a function of supply and demand, it is a natural outcome of any market. As such, it is important to be aware of the price impact of your trades and take the necessary steps to minimize it.
Slippage vs price impact
Although closely related, slippage and price impact are separate concepts. Slippage occurs due to market factors external to the trader while price impact occurs due to the size of a trade relative to the available liquidity.
Please refer to the Slippage page for more details.
DEX price impact
Due to the varying DEX order matching mechanisms, price impact tends to be more pronounced for users on AMM DEXs as opposed to order book DEXs.
AMM price impact
Every AMM pool maintains a ratio of tokens against which trades are made along a price curve. As a result of this design, trading against a pool means adding one token to the pool while simultaneously removing the other token. For example, if a trader swaps 1 ETH for DAI in an ETH/DAI pool, the trader is adding 1 ETH to the pool while withdrawing 1600 DAI (assuming market price of the next 1 ETH is 1600 DAI). Given that the token ratio is a key determinant of pool price, this inverse movement of token quantities results in even greater price movements as the supply of the token being bought (i.e. DAI) drops while the supply of the token being sold increases (i.e. ETH).
The AMM price curve design ensures that the price per token scales with the available liquidity in the pool. Nonetheless, this results in higher price impact risks for pools with less liquidity as prices increases exponentially for every additional token. To mitigate price impact risks, it is advisable to split large trades across different pools or you can use an aggregator (e.g. KyberSwap Aggregator) which automatically splits and reroutes trades to the most capitally efficient liquidity sources.
Order book price impact
Price impact does not apply to order book DEXs in the conventional flow as active limit orders are only executed when a matching order is found. As such, setting a limit order that is within the bid-ask spread sidesteps any price impact risks as limit orders will be filled when the current market price matches the limit order ask. Put in another way, the "impact" that your limit order has on the market is that you are creating a price floor or ceiling for the asset.
Where price impact does come into play is when a trader sets a limit order that is significantly above or below the market price. This might happen accidentally due to mistaken input parameters or as part of more complex trading strategies to secure large amounts of tokens at predefined prices (i.e. according to active limit orders). In such cases, price impact is limited to the difference between the limit order price and the market price.
Protecting our users
KyberSwap's highest priority is the safety of our users. As such, we have implemented multiple safeguards to ensure that traders using our platform do not receive any unwelcomed surprises.
By splitting and rerouting trades across multiple liquidity sources, the KyberSwap Aggregator minimizes the potential price impact incurred from any single source. Moreover, the KyberSwap Aggregator enables traders to set a Max Slippage to guarantee that trades are only executed if the final price is within the expected price range.
Lastly, KyberSwap Limit Orders will always attempt to fill active orders at the market price. KyberSwap Limit Orders have been integrated with the KyberSwap Aggregator to ensure a larger potential pool of liquidity sources which reduces the potential price impact of an order.
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FAQs
If traders wish to avoid the effects of price impact on a DEX, they can always set their trade limit order within the boundaries of a bid-ask spread. This means that the order will be executed once the limit order threshold is reached on a market price level.
How do you calculate the price impact? ›
To calculate the Price Impact, multiply the volume of shares traded by the price of the security and the direction of the trade. Divide this result by the total volume of shares available for trading. The result will give you the Price Impact in percentage.
Why does it say price impact too high? ›
The price impact you experience depends on the size of the liquidity pool. When the pool has high liquidity, your trade may have a smaller price impact. When the pool has low liquidity, your trade may have a larger price impact. Therefore, the larger the price impact, the worse overall price you may receive.
What is the price impact of KyberSwap? ›
Price impact refers to the change in the market price that is brought about due to the execution of a transaction. Price impact is determined by the trade size relative to the available liquidity.
How to avoid high price impact in Coinbase? ›
While it's impossible to completely avoid slippage, traders can minimize its impact by using limit orders, setting a slippage tolerance, and opting for platforms with high liquidity.
Is price impact the same as slippage? ›
Price slippage refers to the change in price caused by external broad market movements (unrelated to your trade). Slippage may be lower or higher than the price impact, but in a short period of time, if no other traders participate, slippage will be equal to the price impact.
What is an example of a price impact? ›
For example, if you are trying to buy $10,000 worth of a cryptocurrency at the current market price and decide to use a Market Order to place your large buy order, due to high volatility, the market price of the cryptocurrency may change rapidly, causing you to receive a different amount of crypto than what you ...
What is the price effect formula? ›
Price effect
Hold quantities at the new level, look at the effect of change in price (so it is isolated from other effects). This could also be called price erosion. The spreadsheet formula conceptually looks like this: = (salesNewtotal)/sum(new_quantities * old_prices) ) –1.
Is there a formula for impact? ›
The following formula gives us the impact force on an object: F = Δ E / s , where is the (average) impact force, is the change in kinetic energy of the object, and is the distance over which the change in kinetic energy happened.
How does price impact work? ›
Price Impact is the influence that swapping has over the market price of the underlying asset pair. It is directly related to the number of funds in the pool.
Price impact is the influence that a user's trade has over the market price of an underlying trading pair. It is directly related to the amount of liquidity in the pool. Price impact can be particularly high for illiquid trading pairs and in certain instances can cause significant losses for traders.
How do you answer the price is too high? ›
In addressing the “price is too high” objection, it's crucial to differentiate your offering from competitors. This could involve highlighting unique features, discussing your business model, or explaining how your solution can save money and time in the long run.
How to avoid price impact? ›
Since price impact is directly correlated to the liquidity of an asset there is only so much you can do if you're trading an asset with low liquidity. You can either wait for more liquidity to enter that asset you're looking to trade, or lower the size of your trade to reduce its price impact.
How to reduce price impact in Uniswap? ›
How To Solve An “Price Impact Too High” Problem on Uniswap?
- Increasing Slippage Tolerance: you raise the slippage tolerance when processing the transaction to fix the problem.
- Breaking Down Transactions into small quantities: reducing the amount of buying and selling of crypto tokens.
As the number of tokens you buy from the pool increases, the price of the token increases as well. This unfavorable change in price is called price impact. If you are swapping in a pool with very low liquidity, you may receive a very poor price for your swap.
How do you solve for price effect? ›
Price effect
This could also be called price erosion. The spreadsheet formula conceptually looks like this: = (salesNewtotal)/sum(new_quantities * old_prices) ) –1.
How to avoid crypto price impact? ›
To help prevent exposure to price impact or slippage, we recommend that you use Limit Orders instead of Market Orders. A Limit Order is used to buy/sell crypto at a specific price. When you set a Limit Order, you choose the amount of crypto you want to buy/sell, and the price at which you want to buy/sell.
How do you pass a price increase? ›
Give your customers plenty of notice and explain the reasons behind the increase, whether it's due to rising costs or because you're enhancing your services. People appreciate honesty and are more likely to understand if they see why the change is necessary."
How do customers respond to price changes? ›
The law of demand states that if all other market factors remain constant, a relative price increase leads to a drop in the quantity demanded. Inelastic demand means consumers are more willing to buy a product even after price increases. High elasticity means even small price increases may significantly lower demand.
