What Is a Liquidation in Crypto

Liquidation in cryptocurrency is a situation when your trade, opened using borrowed funds (leverage), is forcibly and automatically closed by the exchange. This happens when the price of the asset moves in the direction opposite to your position, and your own collateral (margin) becomes too small to secure the trade. Simply put, you lose the money you invested in the trade, and the exchange closes it to avoid losing its own.

Let's take a closer look at how this mechanism works, why it triggers, and how to avoid it.

What Is Margin Trading?

Liquidation is a direct consequence of margin trading—a method whereby trading is conducted with money borrowed from an exchange or other traders on that exchange.

The amount of other people's money you use in relation to your own determines your leverage. For example, if you take 10x leverage (or 1 to 10), it means that for every USDT you have, the exchange adds nine more. You have contributed $10 of your own capital (this is your collateral, or margin), and you are managing a position worth $100. The more leverage you take (for example, 50x or 100x), the less price movement against you is needed for you to lose your entire collateral.

In traditional markets, money for trading is usually provided by banks, while in the world of cryptocurrencies, the source of liquidity is often other users or pools of funds on the exchange itself. They receive interest for this. Since the exchange guarantees that these borrowed funds will be repaid, it has to quickly close unprofitable trades to prevent you from going into debt. Therefore, liquidation always happens very quickly and automatically.

When Liquidation Occurs?

Liquidation does not occur by chance but at a precisely defined moment, which can and must be calculated.

In fact, the exchange tracks two critical price points related to your trade: liquidation price and bankruptcy price.

• Liquidation price always triggers slightly earlier than the bankruptcy price.

• Bankruptcy price is the price at which your own collateral (margin) in this trade will be completely wiped out.

The exchange initiates a forced closure of the position when the liquidation price is reached to ensure that there are sufficient funds remaining to cover administrative and liquidation fees. Thus, the closure occurs earlier to prevent your account from going into the red and the exchange from remaining in debt.

So, it is the liquidation price that you need to watch most closely.

What Happens When You Are Liquidated?

The consequences of liquidation are not only the loss of money but also additional expenses, as well as a complete loss of control over your position.

When you are liquidated, the exchange immediately and forcibly closes your trade at the current market price. You lose all of the Initial Margin (initial deposit) that you contributed to this trade. Moreover, a liquidation fee is deducted from the remaining funds. The entire process takes place without your participation.

What Is the Liquidation Fee?

Liquidation is not free. The exchange charges a special commission for having to urgently close your unprofitable position. This fee is necessary to cover operating costs and potential losses that may arise in the process of closing the transaction.

The amount of this fee depends on the amount of your debt and can be, for example, 2% of the amount to be repaid. This fee is always charged only once for each liquidated position. It is important to know how this fee is charged:

• If you have sufficient funds remaining after liquidation, the commission is debited in full.

• If the remaining funds are insufficient, the exchange will take the entire remaining amount that you had.

All collected liquidation fees are sent to a special insurance fund. This fund acts as a critical safety net for the entire derivatives trading system.

Example of Liquidation

To see how this works in practice, let's look at a simple example of calculating the liquidation price for trades using isolated margin. Let's take as an example a trade on a Bitcoin contract (BTC/USDT) with the following standard conditions:

• Minimum required collateral (Maintenance margin, MMR): 0.5%.

• Price at which you entered the trade (Entry price): $75,000 USDT.

• Trade size: 1 BTC.

• Leverage: 50x.

Long Position

The trader opens a long position. Liquidation will occur if the price falls.

To open a position for 1 BTC worth $75,000 with 50x leverage, you only need to deposit 1500 USDT of your own collateral (initial margin). The exchange requires that a minimum of 375 USDT remain in the account (maintenance margin). This means that you can withstand a loss of 1125 USDT (1500 minus 375).

1. Calculation. Your allowable loss is 1125 USDT. Since you are trading 1 BTC, for your funds to be liquidated, it is sufficient for the price to fall by $1125.

2. Liquidation price. $75,000 (entry price) – $1125 (allowable loss) = $73,875 USDT.

If the price of Bitcoin falls to $73,875, your position will be automatically closed. You will lose 1125 USDT, plus the liquidation fee.

It is important to remember that you can always add more money to your position. If, for example, you add $3,000 USDT of additional collateral, your liquidation price will move significantly. In this case, it will become $70,875 USDT. This shows how an additional investment makes your trade more stable.

Short Position

The trader opens a short position. Liquidation will occur if the price rises.

The initial margin and minimum required collateral remain the same: 1500 USDT and 375 USDT, respectively. Your allowable loss before liquidation is again 1125 USDT.

1. Calculation. In this case, the price must rise by $1125 to incur a loss of 1125 USDT.

2. Liquidation price. $75,000 (entry price) + $1125 (allowable loss) = $76,125 USDT.

If the price of Bitcoin rises to $76,125, the exchange will forcibly close your position.

Simple formulas for calculating this “dangerous price” in isolated mode are as follows:

• For a long position: liquidation price = entry price – (Difference between Initial and maintenance margin divided by trade size).

• For a short position: liquidation price = entry price + (Difference between Initial and maintenance margin divided by trade size).

How to Track Liquidations?

Tracking how many trades are being forced to close helps traders understand the overall market sentiment and where the price might go.

Liquidation rarely happens to a single trader. If the price reaches a level where there are a lot of “dangerous prices” (liquidation prices) for many traders, a domino effect begins, which is called “cascade liquidation”.

Here's how it works: as soon as the price falls to a critical level, exchanges automatically close many long positions. These forced sales sharply increase pressure on the market. That is why tracking liquidation clusters using special analytical platforms is an important tool for traders.

Popular Resources for Monitoring

There are special analytical websites that collect data on liquidations from the largest exchanges:

1. CoinGlass. It shows the total amount of traders' liquidations (longs and shorts separately). The most useful tool is Liquidation Maps (Heatmaps). They show at which price points large volumes of open positions are concentrated that can be liquidated. Traders use these maps to understand where the price is most likely to go in order to “collect” this liquidity.

2. CoinAnk. This platform also offers important visualization of liquidation volumes and open interest. By analyzing this data, you can assess the emotional state of the market and determine whether it is overheated by excessive leverage, which may indicate a high probability of a sharp pullback.

These two platforms are among the most popular choices due to their useful visualization features. However, there are many other analytical services and tools for monitoring liquidations on the market. You can find them yourself using search engines and choose the one that you find most convenient and informative.

How to Avoid Liquidations?

Liquidation is not a failure in forecasting but a failure in risk management. To avoid this, you need to strictly adhere to discipline.

1. Choose conservative leverage.

The main rule: the lower the leverage, the further your “dangerous price” is from the price at which you entered the trade. If you use low leverage (e.g., 3x or 5x), your position will be able to withstand normal market fluctuations.

Beginners should definitely not use high leverage (X50, X100). It almost guarantees that you will be liquidated at the slightest unfavorable price movement.

2. Limit your capital in a single position

Never put all your money into one trade. If you use a smaller portion of your total capital with moderate leverage, you reduce emotional stress. This is very important because fear and panic often lead to irrational decisions and, ultimately, liquidation.

3. Give preference to isolated margin

If you are a beginner, trade in isolated margin mode. As we discussed, it limits your risk to only the money you have allocated to a specific trade. If something goes wrong, you will only lose that amount, and the rest of your capital in the account will be safe.

4. Proactively add margin

In isolated margin mode, you have a chance to save your position. If the price is moving against you, but you are still confident in your trade, add additional collateral manually. This will push back the liquidation price, give the trade time to weather the volatility, and reduce your risk.

5. Monitor your maintenance margin requirements regularly

Exchanges can change their rules. On many platforms, the minimum margin requirement (MMR) increases if you open very large positions. When the MMR increases, your liquidation price approaches the entry price, making the position more vulnerable. Always check to see if these requirements have changed.

6. Always use a stop-loss

A stop-loss is your insurance. It is an order to the exchange to close your position when the loss reaches a predetermined level that is acceptable to you. Set your stop-loss before the price reaches the liquidation level — this allows you to keep the rest of your margin and avoid additional costs in the form of a liquidation fee.

Liquidation in cryptocurrency is the automatic and inevitable end of a trade that was opened with leverage but failed to stay afloat. It is a protective mechanism that kicks in when your collateral becomes too small to cover the loan. The key to success here is not perfect knowledge of where the market will go, but strict discipline and risk management.

We hope that you now understand what liquidation in cryptocurrency is, how it happens, and how to avoid it. If you still have questions, feel free to ask them in the comments!