Cryptocurrency has become an unavoidable topic of discussion over the past decade. One direct consequence is the growing popularity of trading, investing, and portfolio management practices. Among these practices lies crypto liquidation, a critical concept for every investor or trader to grasp.
This article explains what crypto liquidation is, how it works, and why it matters.
What Is Crypto Liquidation in Trading?
Crypto liquidation is the mechanism through which a trader mitigates risks when opening positions in the cryptocurrency market.
When traders open a position, they often use leverage, meaning they borrow funds from a broker or trading platform. This allows them to invest larger sums compared to what they could with their own capital. However, this technique also carries risks, as traders can lose more than their initial investment.
Crypto liquidation typically occurs in the context of short selling. Traders often borrow cryptocurrencies, betting on a price drop (short position). If the price falls, they buy back the borrowed assets at a lower price to profit. But if prices rise, they incur losses and risk liquidation.
Liquidation is triggered when a cryptocurrency's price moves unfavorably against the trader’s position, causing its value to fall below the maintenance margin required by the trading platform.
What Is the Maintenance Margin?
The maintenance margin is the minimum funds a trader must keep in their account to avoid liquidation. If the position's value drops below this threshold, the platform may automatically close it to limit losses by selling the borrowed assets.
Many experts view crypto liquidation as a protective mechanism, helping traders navigate a volatile market where prices can shift unpredictably.
Which Trading Positions Can Lead to Crypto Liquidation?
Most positions prone to liquidation involve leveraged trading, whether long or short. However, short positions are riskier because traders bet on price declines. If prices rise instead, losses escalate, leading to liquidation.
A short squeeze is a prime scenario for liquidation. Here, many traders with short positions face rising prices, forcing them to buy back assets quickly to cover losses—further driving prices up and triggering liquidations.
Long positions (buying crypto to sell later at higher prices) face liquidation risks if prices drop significantly.
Which Trading Tools Can Worsen Crypto Liquidation?
Advanced trading tools can amplify liquidation risks:
- Stop-Loss Orders: Automatically sell assets at a predetermined price to limit losses. However, rapid market drops can execute stop-loss orders at unfavorable levels, magnifying losses.
- Leverage: While it boosts potential gains, excessive leverage increases liquidation risks if maintenance margins aren’t met.
Types of Crypto Liquidation
Partial Liquidation
A newer concept, partial liquidation, lets traders retain part of their position while reducing exposure to market volatility. Not all platforms offer this feature.
Full Liquidation
The standard process where a leveraged position is entirely closed if the asset’s price falls below the maintenance margin. The platform sells the borrowed assets to limit further losses.
Crypto Liquidation by the Numbers
The crypto industry has witnessed massive liquidations, such as:
- May 19, 2021: Bitcoin dropped 30%, liquidating $8 billion in positions.
- April 2023: Bitcoin surged past $30,000, liquidating **$107 million** in short positions.
Traditional markets also see liquidations, like Volkswagen’s 2008 short squeeze (shares rose from €210 to €1,000) and GameStop’s 2021 rally (from $17 to $347), costing short sellers billions.
How to Avoid Crypto Liquidation
- Risk Management: Never risk more than 1–2% of your capital per trade.
- Stop-Loss Tools: Use them wisely to cap losses.
- Leverage Carefully: High leverage amplifies both gains and losses. Use it prudently.
Conclusion
Crypto liquidation is a double-edged sword—protective yet potentially devastating. Understanding leverage risks and adopting sound strategies are crucial. For beginners, platforms like 👉 OKX offer leveraged trading with competitive fees and robust tools. Always trade responsibly and only invest what you can afford to lose.
FAQ
What is crypto liquidation?
It’s the forced closure of a leveraged position when its value falls below the maintenance margin.
Which crypto investments are prone to liquidation?
Primarily leveraged trades, especially short positions.
How can I avoid liquidation?
Manage risks, use stop-loss orders, and avoid excessive leverage.