Liquidation Process in Leveraged Futures

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Definition

The liquidation process in leveraged cryptocurrency futures trading refers to the forced closure of a trader's open position by the exchange when the margin held in their account is insufficient to cover potential losses. This mechanism is designed to protect the exchange and other market participants from default risk associated with leveraged trading. This topic is a critical component of the Introduction to Cryptocurrency Futures Trading pillar page.

Liquidation primarily occurs when the unrealized losses of a position erode the initial margin and maintenance margin requirements, leading the account equity to fall below the maintenance margin level.

Why it matters

Understanding liquidation is essential because it represents the maximum potential loss for a leveraged futures trade, typically resulting in the loss of the entire margin allocated to that specific position. Unlike spot trading, where an asset can only lose value down to zero, leverage amplifies both gains and losses, making the liquidation threshold a crucial price point to monitor.

How it works

Leveraged trading requires a trader to post a small percentage of the total contract value as collateral, known as margin.

Margin Requirements

Initial Margin

The minimum amount of collateral required to open a leveraged position.

Maintenance Margin

The minimum amount of equity required to keep a leveraged position open. If the account equity falls to this level due to adverse market movements, a liquidation event may be triggered.

The Liquidation Threshold

When the market moves against a trader's position, the exchange continuously monitors the Margin Ratio or Margin Level of the account. If the loss causes the account equity to drop to the maintenance margin level, the system initiates liquidation.

The price at which the margin requirement is breached is often referred to as the liquidation price. This price is calculated based on the entry price, the size of the position, the leverage used, and the current funding rate (for perpetual contracts).

The Liquidation Event

When liquidation is triggered, the exchange automatically closes the trader's position to prevent further losses that could result in a negative balance.

For individual traders, this closure is often immediate and executed at the prevailing market price, which may be slightly different from the calculated liquidation price, especially during periods of high volatility. On some platforms, if the account balance falls below zero due to rapid market movement (a 'slippage' during liquidation), the exchange or an insurance fund may absorb the resulting deficit.

For Perpetual Contracts, liquidation is typically handled by an automated system. For Expiry Contracts, liquidation occurs if the position is not closed before the contract expires and settles.

Practical examples

Consider a trader opening a long position on BTC perpetual futures using $100 of margin with 10x leverage. The total contract value is $1,000 (10x the margin).

If the price of BTC falls significantly, the unrealized loss begins to eat into the $100 margin. If the contract falls by 10% (a $100 loss), the entire initial margin is theoretically lost. Because leverage amplifies the loss relative to the margin, the actual price drop required to trigger liquidation is much smaller than 10% of the total contract value. The exact liquidation price depends on the specific exchange's margin calculation methodology, but it will be the price point where the margin equity hits the maintenance level.

If the trader had used 5x leverage with the same $100 margin, the total contract value is $500. The position can sustain a larger price movement before the $100 margin is depleted, resulting in a lower (less risky) liquidation price compared to the 10x position.

Common mistakes

A common mistake is failing to account for Funding Rates in Crypto Futures]]: How Regulations Affect Market Dynamics when holding perpetual positions over time, as these rates can subtly increase or decrease the margin balance. Another frequent error is using excessively high leverage, which drastically narrows the difference between the entry price and the liquidation price, making the position highly susceptible to minor market fluctuations. Traders should also be aware that liquidation closure might occur at a price slightly worse than the calculated liquidation price due to market slippage, especially when using high leverage.

Safety and Risk Notes

Leveraged futures trading carries a significant risk of substantial loss, potentially exceeding the initial investment if the exchange's insurance fund cannot cover the deficit created by rapid market movements. Traders must fully understand the margin mechanics of the specific exchange they use. It is advisable for beginners to start with low leverage or utilize risk management tools such as stop-loss orders, which are designed to automatically close a position before the maintenance margin is breached.

References

Sponsor	Link	Notes
Paybis (crypto exchanger)	Paybis (crypto exchanger)	Cards or bank transfer.
Binance	Binance	Spot and futures.
Bybit	Bybit	Futures tools.
BingX	BingX	Derivatives exchange.
Bitget	Bitget	Derivatives exchange.

Liquidation Process in Leveraged Futures

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