The crypto market's inherent volatility makes leveraged trading both lucrative and risky. Understanding liquidation—the forced closure of a margin position—is critical to safeguarding your capital. This guide explains how liquidations occur, their triggers, and strategies to avoid them.
Understanding Crypto Liquidation
Liquidation happens when a leveraged trade no longer meets margin requirements, prompting an exchange (centralized or decentralized) to close the position automatically. This occurs when:
- The asset’s price moves against your position.
- Your margin balance drops below the liquidation price (the threshold set by the exchange).
👉 Learn how to calculate your liquidation price
Key Terms
- Leverage: Borrowed funds amplifying your position size (e.g., 10x leverage turns $100 into $1,000 exposure).
- Margin: Collateral required to open/maintain a trade.
- Liquidation Price: The price level at which your position is forcibly closed.
How Liquidation Works
Step-by-Step Process
- Open a Leveraged Position: E.g., $100 margin + 20x leverage = $2,000 position.
- Price Movement: If the asset’s value drops by 5% (for 20x leverage), your margin is exhausted.
- Margin Call: The exchange may alert you to add funds.
- Liquidation: Without additional margin, the position is closed, and you lose the initial margin.
Types of Liquidation
- Partial: A portion of the position is closed early to reduce risk.
- Total: The entire position is liquidated.
Why Crypto Liquidations Occur
- Risk Management for Lenders: Exchanges liquidate positions to recover borrowed funds.
- High Volatility: Rapid price swings trigger margin shortfalls.
- Protocol Rules: DeFi platforms (e.g., MakerDAO) enforce liquidation to maintain system stability.
Example: On MakerDAO, staking ETH at 150% collateralization means a price drop below this threshold triggers liquidation, incurring a 13% penalty.
Calculating Liquidation Price
Use this formula:
Liquidation % = 100 / Leverage
- 25x Leverage: Liquidation occurs at a 4% price drop (100/25).
- 100x Leverage: Just a 1% drop can liquidate your position.
👉 Optimize your trading strategy
Avoiding Liquidation: 4 Strategies
- Lower Leverage: Reduces sensitivity to price swings.
- Stop-Loss Orders: Automatically closes positions at predefined loss thresholds.
- Trailing Stop-Loss: Adjusts the exit price as the market moves favorably.
- Monitor Margin Levels: Add funds proactively if margins deplete.
FAQs
1. What happens after liquidation?
You lose your initial margin, and the lender reclaims borrowed funds. Some exchanges charge liquidation fees.
2. Can I recover liquidated assets?
No—once liquidated, the position is closed permanently.
3. Do decentralized platforms liquidate?
Yes. Protocols like Aave and MakerDAO enforce liquidations to protect lenders.
4. How do exchanges determine liquidation price?
Based on leverage, margin balance, and asset volatility.
5. Is high leverage always risky?
Yes. Higher leverage increases liquidation risk exponentially.
6. Can I avoid margin calls?
Only by maintaining sufficient margin or reducing position size.
Final Thoughts
Liquidation is an unavoidable aspect of leveraged trading. Mitigate risks by:
- Using conservative leverage.
- Setting stop-loss orders.
- Continuously monitoring margins.
👉 Master crypto trading with minimal risk
By adopting disciplined strategies, you can navigate volatility and protect your capital from abrupt liquidations.