The DeFi ecosystem uses two alternative methods for determining asset prices: TWAP and VWAP. When determining asset values, a key component of practically all decentralized finance (DeFi) primitives, the time-weighted average price (TWAP) and volume-weighted average price (VWAP) algorithms employ various techniques. Trading success rates for individuals who included anchored VWAP in their approach were over 70% as opposed to just 50% for the people who would not.
This article discusses the distinctions between the TWAP and VWAP algorithms and how they function when pricing assets in Algo Trading App. It also examines the benefits and drawbacks of each approach.
DeFi protocols may give consumers more precise, dependable, and fair rates using the most reliable infrastructure while implementing more educated security design decisions. A vital step in this procedure is understanding how TWAP and VWAP algorithms vary.
This article discusses the distinctions between the TWAP and VWAP algorithms and how they function when pricing assets in Algo Trading App. It also examines the benefits and drawbacks of each approach.
DeFi protocols may give consumers more precise, dependable, and fair rates using the most reliable infrastructure while implementing more educated security design decisions. A vital step in this procedure is understanding how TWAP and VWAP algorithms vary.
What is TWAP?
"Time-weighted average price" (TWAP) is a term. A pricing algorithm determines an asset's average cost over a specified period.
In DeFi, an automated market-making (AMM) kind of DEX can be used to provide TWAP pricing that can be incorporated into other protocols.
TWAP can additionally apply to a trading technique that divides a big order into equal portions over a predetermined period to reduce slippage and messaging. Instead of focusing on the trading technique in this piece, we will concentrate on the pricing system.
How Is TWAP Determined?
TWAP is established by adding prices across several points over a certain period and dividing the result by the total price points.
This is a typical TWAP formula:
This is a typical TWAP formula:
> TWAP equals (TP1+ TP2... + TPn) / n,
> where TP1 is the selling price at the first timepoint
> n is the entire amount of time points.
> where TP1 is the selling price at the first timepoint
> n is the entire amount of time points.
Consider the scenario if we wished to use 15-second price point increments to determine the TWAP of a stock over a minute. To get the TWAP, we would add every price point (100, 102, 101, 99, 103) followed by reducing them by the total amount of time points (five) if the prices became $100 at the start of the period, $102 at fifteen seconds, $101 at thirty seconds, $98 at forty-five seconds, and $103 at sixty seconds. The TWAP, in this instance, is $101.
Overview of VWAP
VWAP, or "volume-weighted average price," is an acronym. It is a method for determining an asset's price that weighs price data from various trading environments according to the volume of trades the investment has made in each liquid market. Most DeFi protocols are based on the VWAP algorithm, which is the basis of the market-leading price oracle solution.
The VWAP calculation approach is also widely used in finance as a benchmark for an order option provided by traders or transfers, and a technical indication for traders. We emphasize its usage as a price mechanism in this text. Trading Bot Backtesting is a technique in actual trading that is used to test to see how well it performs.
What Is the Formula For VWAP?
With wash transactions and other outliers often filtered out, VWAP is derived by determining the price at which the asset was exchanged across various trading venues and evaluating those price ranges concerning the total amount transferred on each exchange.
Here is a typical VWAP equation:
Here is a typical VWAP equation:
- VWAP is calculated as (V1 x P1 + V2 x P2... + Vn x Pn) / Total Volume,
- where V1 and P1 represent the volume and price at which an asset was exchanged in the first trading setting, respectively,
- n represents all of the trading scenarios that were taken into account.
You will compute the VWAP of a speculative asset over a given period as an illustration. Let us imagine that on exchange X, 100 tokens were exchanged for $101; on exchange Y, 150 tickets were bought for $102; and on exchange Z, 500 cryptocurrencies were traded for $100.
We multiply the outcomes by the total volume traded (100 + 150 + 500) after multiplying the price by the volume in each trading scenario (100 x 101 + 150 x 102 + 500 x 100). The result of multiplying 75,400 by 750 is a VWAP of $100.53.
We multiply the outcomes by the total volume traded (100 + 150 + 500) after multiplying the price by the volume in each trading scenario (100 x 101 + 150 x 102 + 500 x 100). The result of multiplying 75,400 by 750 is a VWAP of $100.53.
Difference Between VWAP and TWAP Algorithms
As soon as you are familiar with both the volume-weighted average and time-weighted average prices, let us examine how they differ. According to one study, increasing the average price accuracy can increase VWAP reliability by up to 50%. Algorithmic trading techniques use technical indicators like conventional online stock trading strategies do. The following table outlines the distinctions between VWAP and TWAP.
VWAP | TWAP |
The volume-weighted average price is the full name of VWAP. | The time-weighted average price is the full name of TWAP. |
VWAP is calculated using the following formula: VWAP = Typical Price*Volume/Cumulative Volume | The calculation of TWAP is done using the following formula: TWAP of X days = (Average Price of Day 1 + Average Price of Day 2 + Average Price of Day 3 +... + Average Price of Day X)/X |
VWAP's Typical Price equals high price + low price + closing price/3. | For TWAP, the formula for calculating the average price each day is open price + close price + high price + low price/4. |
To calculate the VWAP, volume and time are important factors. | The TWAP solely takes the time criteria into account. |
The VWAP trading technique is less predictable and more dependable since it depends on several variables. | The TWAP trading technique is predictable since there is only one variable it depends on. |
Consequently, the VWAP is seen as being the more sophisticated of the two. | The TWAP, on the other hand, is viewed as being more rudimentary. |
Advantages & Disadvantages of TWAP vs VWAP
The main benefit of TWAP is its ease of use—additionally, dividing big orders into more manageable ones and reducing slippage, and signaling risk aids in risk reduction. The drawback of TWAP is that it uses a linear implementation model without taking volume changes into account, which might lead to an erroneous portrayal of the genuine market price.
The significant benefit of VWAP is the fact that it aids in determining critical liquidity zones and determining market movements, such as bullish or bearish. Additionally, it considers the volume exchanged, providing a more accurate depiction of the genuine market price. It is harder to utilize and is more susceptible to market volatility, though.
The significant benefit of VWAP is the fact that it aids in determining critical liquidity zones and determining market movements, such as bullish or bearish. Additionally, it considers the volume exchanged, providing a more accurate depiction of the genuine market price. It is harder to utilize and is more susceptible to market volatility, though.
Conclusion
The foundation of effective and secure DeFi systems is accurate and impermeable pricing data, ensuring that consumers get an appropriate value for their belongings and that bad actors cannot influence prices. VWAP-based price structures are more relevant than TWAP computations to test your trading strategies.
To better assist users, initiatives, and the industry, protocols may easily include VWAP-based pricing data that is highly trustworthy, high-quality, and autonomous at several levels.
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