Liquidation
Liquidation is the forced, rule-based sale of a trader's or borrower's collateral when a position becomes too risky, so that the debt or loss can still be covered. It happens automatically, without asking you first.
Two places liquidation happens
On trading platforms, leveraged positions are backed by margin. If the price moves against you until your margin falls below the maintenance margin, the exchange closes the position. The price where this happens is your liquidation price.
In DeFi lending, a loan is backed by collateral. When the collateral's value falls far enough relative to the debt, often shown as a health factor dropping below 1, anyone can repay part of the loan and receive the collateral at a discount. That discount is the liquidation penalty you pay.
An example
Say you open a long BTC position worth 10,000 dollars with 1,000 dollars of margin, which is 10x leverage. A price drop of roughly 10 percent wipes out your margin, so the exchange liquidates you somewhat before that point, because it keeps a maintenance buffer and fees. You lose most or all of the 1,000 dollars, even if the price recovers an hour later.
Why it matters for the whole market
When many leveraged positions sit at similar levels, one liquidation can trigger the next: forced selling pushes the price down, which hits more liquidation prices. This chain reaction, a liquidation cascade, explains many sudden wicks on crypto charts. Short positions can be liquidated the same way when prices jump, which is called a short squeeze.
How to reduce the risk
Lower leverage moves the liquidation price further away. Adding collateral or repaying debt raises a DeFi health factor. Knowing the exact liquidation price before opening a position, and remembering that fees, funding payments and fast markets can bring it closer, helps avoid surprises. Stop-loss orders can close a position at a planned loss before liquidation, though in fast moves they may fill at a worse price.
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Frequently asked questions
Can I lose more than my margin in a liquidation?
On most crypto exchanges your loss is limited to the margin of that position, and insurance funds or auto-deleveraging cover any shortfall. With cross margin, though, other balances in the account can be used.
What is a liquidation penalty?
An extra fee taken from your collateral during liquidation. It rewards liquidators in DeFi or funds an exchange's insurance fund.
How do I find my liquidation price?
Exchanges show it on the position screen; DeFi apps show a health factor or liquidation price for each loan. It changes when you add margin, add collateral or pay fees.
Related terms
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