What Is a Time-Weighted Automated Market Maker (TWAMM)?

TWAMM or Time-Weighted Automated Market Maker is a new approach in the field of decentralized finance ( DeFi ) designed to facilitate the execution of large orders with minimal slippage and low gas fees while mitigating adverse price impacts.

In line with practices in traditional finance (TradFi), where traders typically rely on brokers to algorithmically execute large orders over a certain period of time to secure optimal prices, TWAMM introduces a decentralized solution tailored to the dynamics of the cryptocurrency market. The essence of this concept is the adaptation of the Time-Weighted Average Price (TWAP) order, a well-established mechanism in TradFi, to the decentralized DeFi environment.

In essence, TWAP orders provide traders with the average price of a security or asset over a specified time period, thereby allowing them to execute trades in a way that minimizes market impact and ensures optimal execution. By leveraging the automation and smart contract technology inherent to DeFi protocols, TWAMM seeks to empower traders with increased liquidity and execution capabilities while navigating the complexities of decentralized markets.

Time-Weighted Automated Market Maker (TWAMM) Example

Look at the following illustration. A large-scale trader intends to buy a certain asset in large quantities, say $10 million worth of Solana. Executing large trades all at once will inevitably lead to huge spikes in market prices thereby negatively impacting the trader's goals.

To overcome this, traders typically use trading desks or sophisticated algorithms to break down $10 million worth of orders into smaller, more manageable chunks, often spread over several hours or even days. This approach, known as a Time-Weighted Average Price (TWAP) order, aims to minimize the impact on market prices by spreading trading activity over time.

The TWAMM (Time-Weighted Automated Market Maker) system seeks to replicate the principles of the TWAP command in the field of decentralized finance (DeFi). By breaking down large orders into multiple smaller transactions executed through an automated market maker (AMM) over an extended period of time, TWAMM attempts to execute trades smoothly while minimizing market disruption.

However, this method can cause price differences in the overall crypto market. To overcome this challenge, TWAMM relies on arbitrageurs to intervene, trading against AMM prices to align them with broader market prices, thereby ensuring efficient execution of long-term orders.

Traders utilizing AMMs face challenges similar to those faced in traditional finance due to the inherent limitations of the constant product formula used by AMMs. Executing a large number of buy orders at once may trigger market makers to increase prices against the trader's interests.

On the other hand, manually fragmenting trades to avoid this problem proves cumbersome and incurs additional gas costs as the number of transactions increases. The TWAMM algorithm aims to simplify this process by automating trade subdivisions, optimizing trade execution efficiency and minimizing associated gas costs.

The TWAMM algorithm represents a significant innovation in DeFi, offering users the ability to determine the parameters of buying and selling assets over a specific time period, such as a week or a few hours, without relying on centralized exchanges ( CEX ) or traditional trading desks.

As DeFi and cryptocurrency adoption continues to gain momentum among large investors, features like TWAMM are poised to play a critical role in improving the overall trading experience, driving greater accessibility and use of decentralized exchanges (DEX) in mainstream markets.

Also Read:

What is Interest Rate in Defi?

Cryptocurrency Exchanges, Gateway to the Digital Economy

What is Custiodial?

DISCLAIMER : This article is informational in nature and is not an offer or invitation to sell or buy any crypto assets. Trading crypto assets is a high-risk activity. Crypto asset prices are volatile, where prices can change significantly from time to time and Bittime is not responsible for changes in fluctuations in crypto asset exchange rates.

Related to