Liquidation Definition

Liquidation usually means turning assets into cash. In crypto, it happens when a lender or exchange closes a trader’s position because there isn’t enough margin left to cover the loan. This helps make sure the lender doesn’t lose more than the collateral can cover.

How liquidation works

When someone trades with leverage, they borrow money to increase the size of their position. The platform that lent the funds watches the value of the trader’s collateral. If the collateral falls below a set threshold, the platform triggers an automatic sale to recover the loan. That sale can execute at worse prices than the market, which can make losses larger for the trader.

Types of liquidation

Platforms usually use two main methods. One is to sell part of the position to restore the margin. The other is to sell the entire position so the lender gets all their money back. These are called partial liquidation and total liquidation.

Triggers and technical terms

Here are some terms that help explain why liquidation happens:

• Margin means the collateral you put up to borrow funds.
• Maintenance margin is the minimum collateral level a platform requires.
• Liquidation price is the market price at which the platform will start selling your collateral.
  When the market moves quickly, a position can skip steps. Margin calls might not be enough, and liquidation can happen automatically.

Why liquidations happen

Big price swings in crypto often lead to liquidations. Volatility can quickly lower the value of collateral, so a position that seemed safe can become undercollateralized in minutes. Other reasons include using too much leverage, sudden market gaps, or delays on the exchange that stop useful orders from going through.

How traders try to avoid liquidation

Traders can lower the risk of liquidation by keeping extra collateral, using less leverage, and setting stop-loss orders. It also helps to check margin levels often and avoid putting everything into one position. Each platform has its own tools and rules, so the steps can be different.

Effects on markets and traders

Forced selling can push prices down further, especially when many positions get liquidated at once. For the trader, liquidation can mean losing most or all invested funds and sometimes ending up with a negative balance, depending on platform rules and fees. Exchanges use these mechanisms to protect themselves, but the result can be rapid price moves and higher trading costs for everyone.

Notes on wording and context

Outside of crypto, liquidation can also mean closing a business and selling its assets to pay creditors. In trading, it mainly means automatically closing leveraged positions so lenders get their money back.