The price impact represents the change in the price of an asset depending on how, usually a large, trade moves the market. Single trades have the possibility of affecting price and this is known as the trade's price impact.
When making trades on a cryptocurrency market, the impact of different trades can move the price of the underlying asset. Usually, when there is a buy order, or a number of different buy orders, the price of the asset is expected to move up. This is because the cheapest sell orders become exhausted and the price impact starts to shift towards a higher price.
When there are sell orders, the price of the asset will move downwards and this is another form of price impact. When it comes to noting how much of an impact there is in the price impact, factors such as liquidity, and the amount or size of trades, will give higher movements either way.
More liquid trading pairs will see a smaller price impact than those with lower trading volumes. This is important to note as you are more likely to feel the price impact on smaller trading pairs with less liquidity or with coins that are not as well traded.
This is an important aspect in trading on low liquidity pairs as for a trader looking to make big, or numerous trades, they can feel the price impact heavily across their trades. Their second buy trade will on average be more expensive than the first one because of their impact on the market.
For major traders and even trading firms, the topic of price impact is heavily researched as they try to understand how to control it while making large and numerous trades. These trading firms want to understand how dependent the trade impact is on the trade size and how long it takes for its effect on asset price to manifest fully.
##Price impact too high problem
The issue of price impact has been felt by users in the DeFi sector, notably on Pancake Swap where a persistent issue has arisen. Users of Pancake Swap have been met with a message that reads ‘price impact too high.' This issue shows, in action, what happens with illiquid pairs.
Price impact is the effect that your trade has over the market price of the underlying tokens. It is linked with the amount of liquidity in the pool. The price impact will be especially high for illiquid token pairs.
For example, if you're swapping $190 worth of Ethereum for $80 worth of Dipper Network, the price impact will be about 60%. This is because there is a low number of Dipper Network sellers at the market price to fulfil your order.
If that's the case, you can either wait for more liquidity to enter the market, or decrease the amount swapped, explains Pancake Swap.