Key Takeaways
- Crypto liquidation occurs when your trading account lacks sufficient collateral to support a leveraged position, causing the platform to close your trade and recover its funds.
- The liquidation price is the critical threshold where your position is automatically closed. Factors such as trade size, collateral, and platform rules determine this price.
- Liquidation can occur through partial liquidation, total liquidation, voluntary liquidation, or forced liquidation, each with unique implications for the trader’s position.
- Avoiding liquidation involves using stop-loss orders, reducing leverage, staying informed about market trends and dynamics.
Crypto trading is an exciting yet unpredictable adventure, where opportunity and significant risk go hand in hand. A key strategy in crypto trading is margin trading, also known as crypto leverage trading. This is where traders borrow funds to amplify their positions in a particular crypto asset, with the intention of increasing their eventual profit. While this method is popular in traditional finance, it becomes trickier in the crypto world due to the extreme volatility of digital assets.
Crypto liquidation is one of the biggest threats in leveraged crypto trading. If you’re not prepared, it can wipe out your account quickly.
In this guide, you’ll discover crypto liquidation, how it works, the different types, and, most importantly, how to avoid it.
What is Crypto Liquidation?
Crypto liquidation occurs when a trader’s leveraged position loses too much value. To protect itself, the exchange forces the trader to sell their assets, often at a significant loss. This typically occurs during market crashes when prices plummet rapidly.
Let’s say you’ve borrowed funds to trade Bitcoin, expecting its value to rise. If Bitcoin’s price takes a sharp dive, the exchange may step in and sell off your position to recover the borrowed amount before the situation worsens.
What is Liquidation Price?
Liquidation price is the asset value that triggers an automatic trade closure to stop losses from surpassing your initial investment.
When you use leverage, you borrow funds to increase your trading power. However, if the market moves against you, you could quickly owe more than you are able to pay back. If your position starts losing money, the platform may liquidate your position to recover its funds.
Some factors that affect your liquidation price include:
- Trade size: Larger trades amplify potential gains and increase risk, bringing the liquidation price closer to the market price.
- Collateral: Higher collateral gives you a buffer, pushing the liquidation price further from the current market price. Conversely, minimal collateral increases the chance of liquidation.
- Platform rules: Different exchanges have varying rules on how much margin you need to maintain your position.
Crypto Liquidation – An Example
To better understand this dynamic, let’s use a scenario. Say you borrowed funds to buy Bitcoin at $30,000, expecting the price to go up over time: your liquidation price might be $25,000. If Bitcoin’s value does decrease to $25,000, the exchange will simply liquidate your position to recover its funds.
We’ve seen the effects of large scale crypto liquidations very recently. In mid-2024, as Bitcoin’s price fell to $64,548 and Ethereum dropped to $3,384, about $489 million in positions were liquidated.
Decrypt reported that, of the liquidated positions, $432 million came from long positions— people who had wrongly bet that prices would rise. When it decreased instead, the crypto exchanges who had provided the leverage collateral liquidated the losing positions to prevent any further losses and avoid a situation where their loaned crypto could not be repaid. The largest single liquidation was a $6.4 million Ethereum position on Binance.
Different Types of Crypto Liquidations
Liquidations come in various forms, each affecting your trading account differently. Let’s explore the most common types and what they mean for you as a trader:
Partial Liquidation
In a partial liquidation, the platform closes part of your position and restores your account balance within the required margin limits. This approach helps you avoid a total wipeout by reducing your risk exposure. Think of it as a safety net whereby your trade continues, but on a smaller scale, giving you a chance to recover or reassess your strategy.
Total Liquidation
A total liquidation is more severe. It occurs when the platform closes your entire position because your collateral cannot cover even a fraction of the losses. Once this happens, you lose your collateral and your trade ends.
Voluntary Liquidation
Not all liquidations are imposed. Voluntary liquidation happens when you decide to close your position. Traders often do this to lock in profits or cut losses before reaching the liquidation price. It’s a proactive move, showing that you control your trading decisions.
Forced Liquidation
A forced liquidation takes place when the platform automatically closes your position. This action is taken to prevent further losses to the exchange, especially when your account balance falls below the minimum margin requirement.
Forced liquidation is the platform’s last-resort action. It automatically closes your position when your account balance drops below the minimum margin requirement. This is the platform protecting itself. Your collateral covers the borrowed funds, ensuring the exchange doesn’t lose money. It’s swift, decisive, and leaves no room for negotiation.
How to Avoid Liquidation in Crypto Trading
Liquidation can be daunting, but several strategies can help you reduce the risks:
- Set Stop-Loss Orders: A stop-loss order automatically closes your position when the market moves against you by a specified amount.
- Trade with Lower Leverage: Using high leverage increases your risk exposure. Opt for a lower leverage to keep potential losses manageable.
- Stay Informed About Market Trends: Monitor news, price trends, and market developments to make better trading decisions.
- Diversify Your Portfolio: Spreading investments across different assets can help balance risks.
- Maintain Adequate Margin: Regularly add funds to your margin account to keep it above the required levels.
- Trade Within Your Limits: Avoid overtrading, which can lead to impulsive decisions and heightened risk.
Closing Thoughts
Crypto trading demands a balance between ambition and caution. Liquidation, while intimidating, can be a powerful learning opportunity if approached with the right mindset. Every liquidation type—partial, total, voluntary, or forced—offers lessons in risk management and strategic decision-making.
Traders who take the time to understand these dynamics can turn potential setbacks into steps toward smarter, more resilient trading practices. By staying disciplined and informed, you can navigate the volatility of crypto markets with greater control and confidence.
