Terraswap Liquidity Depth and Slippage: A Deep Dive

In a world of growing Defi adoption, DEXs are increasingly becoming the go to place to swap your assets. Their ease of use, coupled with lack of KYC requirements, makes them an attractive alternative to Centralised Exchanges. However, an important challenge any DEX has to overcome is drawing sufficient liquidity to minimise slippage. If liquidity is too low, slippage fees will drive users elsewhere for their swaps, seeking a better deal. In this report, I use data from Flipside Crypto to analyse Terraswap, the native AMM DEX of Terra, and establish a lower bound of $1.5 million USD liquidity needed to minimise slippage. I also show that market sentiment is a key driver of slippage. In periods of high greed, swappers are more tolerant to accept high slippage as they fomo into assets. Similarly, in periods of high fear, swappers rush to protect their portfolio by converting to stable coins, and accept higher slippage in the process.

What is Slippage?

Slippage is the difference between the spot price and the realised price of a trade. A DEX swap will always experience slippage due to the way the pricing models of DEXs work. DEXs use liquidity pools, where the price of the assets is determined by the ratio of one asset to another. A swap adds funds to one side of the pool and takes funds from the other, putting it out of balance, and hence causing slippage. In practice, slippage tends to 0 as liquidity depth grows sufficiently large, since the relative amount a swap puts the pool out of balance will be minimal. However, a pool with low liquidity and large swaps can suffer significant slippage.

If you are wondering how bad it can get, I found this poor soul while digging through the data who paid 75% slippage on a UST to Luna swap. This cost them a whopping 3000 Luna, which at today’s prices is over $120,000 USD. Quite a lot for a transaction fee…

Figure 1: Terra Finder Output for High Slippage Transaction. Units are m x 10⁶.

Overview of Pools:

Figure 2: Percentage of Swaps with High Slippage by Pool on Terraswap

Here we have the percentage of swaps in each Terraswap pool that suffer high slippage. For this report, I define high slippage as >5% of the transaction value. The trend in the data is very clear. Most pools on Terraswap experience very little slippage, with the single exception being the LOTA-UST pair. A little over 5% of transactions in the LOTA-UST pool suffer high slippage. The second highest slippage count is MINE-UST at just 0.35%. The remaining 31 of 33 pools all have less than 0.1% of transactions with high slippage. When we look at liquidity depth of the pools, it becomes clear what is going on.

Figure 3: Depth of Liquidity (USD) by Pool on Terraswap

In figure 3 we can see the pool depth of all Terraswap pools in USD. The deepest pool is the ANC-UST pair at over $150 million USD pooled, and unsurprisingly the lowest is the LOTA-UST pair, at just 322k USD. Marginally deeper than the LOTA-UST pool is LUNA-MNT, with 1.5 million USD in liquidity. However, LUNA-MNT sees just 0.04% of transactions suffering high slippage. From this we can establish an initial lower bound of liquidity necessary to prevent high slippage at 1.5 million USD.

Impact of Transaction Sizes:

A hypothesis proposed by Loop Finance is that average trade size in a given pool might impact the amount of slippage a pool sees. This makes sense, since larger transactions put pools more out of balance, and hence are more prone to slippage. However, when we look at the data, we see the complete opposite trend.

Figure 4: Average Transaction Size (USD) on Terraswap by Pool

The LOTA-UST pool, which has the highest percentage of transactions suffering significant slip, in fact has the lowest average transaction size. The average transaction size across all pools is $4237 USD, while it is just $628 USD for the LOTA-UST pool. Instead of transaction sizes driving slip, the opposite is true: transaction sizes are responsive, and react to the depth of available liquidity. This gives us an important insight into the behaviour traders on Terraswap. It tells us that they are observant, and pay close attention to slip. They will not blindly accept a high slip swap (except for our unfortunate friend in the LUNA-UST pool), but instead will go elsewhere for a swap if it is more affordable. As convenient as Terraswap is to use, slippage will still drive traders away from the platform when it lacks liquidity.

Historic Analysis of LUNA-UST Pool:

Figure 5: Weekly percentage of transactions experiencing high slippage in LUNA-UST pool

Hoping to refine my lower bound estimate of liquidity sufficient to minimise slippage, I looked at the historic slippage rate of pools over time. A good example is the LUNA-UST pool, since there is a large sample size of transactions over a long period of time. However, there is no clear turning point in slippage frequency, and no obvious point at which we can claim liquidity is sufficiently deep. Instead, we see consistently very low slippage, with a large spike on the week starting Feb 8th.

This spike to over 15% of transactions suffering high slippage was caused by the first Luna bull-run. Investors rushed to cash out their Luna to UST, and in the process were willing to accept higher slippage. Exacerbating this, user’s were pulling their liquidity out of the pool to take profits and minimise impermanent loss, which increased the slippage on every transaction. Looking at figure 6, we can see what almost looks like a gap in the data in the daily pool liquidity. It dropped from 5.3 million USD on the 7th Feb to just 15.3k on the 8th. This hints at an idea I have discussed in some of my THORChain Data Digest reports. Market sentiment, and in particular high fear and high greed, are key drivers of slip payments on decentralised exchanges.

Figure 6: LUNA-UST Pool Daily Liquidity (USD) since launch of Terraswap

Market Sentiment and Slippage:

Market sentiment plays an important role in the tolerance of a trader to accept slippage. In periods of extreme greed, investors get blinded by the fomo and accept higher slip payments if it means they can get their hands on the asset. Similarly, in periods of extreme fear, investors rush to convert their assets to stable coins to protect their portfolios, accepting higher slip in the process.

Figure 7: Percentage of transactions with High Slippage in periods of varying Market Sentiment

Across all Terraswap pools, the baseline occurrence of transactions with high slip was 0.08% (all transactions across all pools since launch of terraswap). In periods of extreme fear this increased to 0.11%. In periods of extreme greed this was a staggering 0.22%. Greed above all appears to be a key driver of high slippage on Terraswap.

Conclusion:

Slippage on Terraswap is driven by lack of liquidity, and accelerated by market sentiment. 31 of the 33 pools on Terraswap experience high slippage very rarely, in less than 0.1% of transactions, and a lower bound of $1.5 million USD in liquidity depth is a good starting point to achieve this. However, high greed in the market can accelerate slippage, as investors fomo into the next must-have asset. Similarly, high fear can do the same, as investors panic sell into stable coins to protect their portfolio.

Msc Maths and Computer Science Student, Tsinghua University