Definition
Liquidation is a risk-control mechanism used by trading platforms to automatically close a trader’s position when the account’s margin is no longer sufficient to support it. In crypto markets, it occurs when the value of collateral backing a leveraged position drops to or below a predefined maintenance margin threshold. The platform then sells or otherwise disposes of the position and collateral to ensure that system-wide losses are contained and that counterparties are made whole.
On both centralized exchanges (CEX) and derivatives venues offering products like perpetual futures, liquidation is tightly linked to leverage and margin requirements. The process is typically triggered by price movements that move against the trader’s position, reducing equity in the account. Once triggered, liquidation converts the position into cash or stable assets at prevailing market prices, locking in realized losses and preventing the account from going into negative balance under normal conditions.
Context and Usage
Liquidation is central to the design of leveraged trading systems because it protects the integrity of the market and the solvency of the platform. In the context of perpetual futures, liquidation thresholds and fees are defined by the exchange’s risk engine, which continuously monitors positions relative to collateral value. Traders rely on parameters such as initial margin, maintenance margin, and liquidation price to understand how close a position is to being forcibly closed.
On a CEX, liquidation is executed according to the platform’s internal rules, which may include partial liquidations, insurance funds, or backstop mechanisms. Concepts like stop-loss order and slippage are often discussed alongside liquidation, since they relate to controlling realized exit prices and managing adverse price moves before a forced close occurs. In highly volatile conditions, rapid price changes and market depth can influence the final execution level at which liquidation is completed.