Liquidation

November 21, 2023 - Around 2 mins mins to read

Understanding Liquidation

Liquidation refers to the process of converting an asset or cryptocurrency into fiat currency or its equivalents, such as Tether (USDT) and other stablecoins. This conversion can be voluntary or forced, with forced liquidation occurring automatically under certain conditions, particularly in margin trading. Margin trading involves leveraging borrowed funds to enhance a trader’s position, and if the trader fails to meet the requirements of a leveraged position, their position is automatically closed.

It is important to understand that margin trading involves leverage, which is the borrowed funds used to amplify a trader’s position. The higher the leverage, the narrower the price range for liquidation.

For example, let’s consider a scenario where a trader wants to margin trade BTC/USDT but only has $50. In this case, the trader would need to borrow $450 to have a leverage of 10x. If the price of Bitcoin drops by 10%, the trader’s investment will be lost, and any further losses will deplete the borrowed funds. To mitigate this risk, the lender will convert their BTC to USDT to recover their share before the price falls further, resulting in the liquidation of the trader’s margin trade.

In some cases, forced liquidation may occur before a trader’s actual share is depleted and may involve charging a fee. However, platforms like Binance provide users with the ability to calculate the liquidation price before entering a leveraged position. The liquidation price is determined based on factors such as the position size, leveraged amount, and account balance.

Aside from margin trades, liquidation also occurs in the futures market.

On the other hand, voluntary liquidation simply refers to a trader choosing to cash out their crypto-assets for personal reasons.