What happens during a liquidation event in leverage trading?

Understanding Leverage Trading and Margin

Leverage trading allows traders to borrow funds to increase the size of their positions beyond their actual capital. When engaging in this type of trading, users deposit a certain amount of cryptocurrency as collateral, commonly referred to as margin. This margin supports the leveraged position. For example, with 10x leverage, a trader can control a $10,000 position using only $1,000 of their own funds. The exchange or platform acts as the lender. The loan-to-value ratio (LTV) is a key metric that reflects how much of the position is financed by borrowed funds relative to the value of the collateral. As market prices fluctuate, the value of the collateral changes, which directly impacts the health of the leveraged position.

What Triggers a Liquidation?

A liquidation event occurs when the value of the trader’s collateral falls below a critical threshold known as the maintenance margin. This threshold varies by platform and leverage level but typically ranges from 0.5% to 5% of the position value. When the market moves against the trader’s position, losses accumulate, reducing the equity in the margin account. Once the equity drops to the point where it can no longer cover the required maintenance margin, the system initiates liquidation. This is designed to prevent the trader from owing more than their initial deposit. The liquidation price is the specific market price at which this threshold is breached. Traders can monitor this price in real time on most trading interfaces.

How the Liquidation Process Unfolds

When the liquidation price is reached, the exchange automatically begins closing the position to limit further losses. This process is fully automated and happens within seconds. The platform uses internal matching engines or auctions to offload the position, often at a price close to the mark price. During high volatility, slippage may occur, resulting in execution at a less favorable rate. The system prioritizes minimizing the platform’s risk. After the position is closed, any remaining funds—after repaying the borrowed assets and fees—are returned to the trader. In many cases, the entire margin is lost, especially in extreme market conditions. Some platforms apply a liquidation fee, which is deducted from the remaining balance as a penalty for the forced closure.

Differences Between Partial and Full Liquidation

Not all liquidations result in the complete closure of a position. Some platforms implement partial liquidation mechanisms for larger positions. In this scenario, only a portion of the position is closed to bring the margin ratio back above the maintenance level. For example, if a $50,000 position with 20x leverage begins to approach the liquidation threshold, the system might close $20,000 worth of the position to stabilize the account. This preserves the remaining exposure while reducing risk. However, full liquidation remains the standard on most centralized exchanges, particularly for retail traders. Full liquidation eliminates the entire position and stops any further exposure to market movement.

Role of Insurance Funds and Bad Debt Protection

To handle scenarios where liquidations fail to cover the full debt—such as during flash crashes or extreme slippage—many exchanges maintain an insurance fund. This fund is sourced from a portion of liquidation penalties and platform revenues. It acts as a buffer to absorb losses when a liquidated position sells for less than the borrowed amount. In rare cases, if the insurance fund is insufficient, the platform may resort to auto-deleveraging (ADL). Under ADL, profitable counterparties with opposing positions are automatically reduced to cover the shortfall. The order of ADL is typically based on profitability and leverage, with the most profitable and highly leveraged traders being affected first. This ensures the system remains solvent without requiring external bailouts.

How to Avoid Liquidation: Risk Management Strategies

Traders can take several proactive steps to reduce the likelihood of liquidation. One effective method is to use lower leverage, which increases the buffer between the entry price and the liquidation price. Monitoring the margin ratio and setting alerts when it approaches critical levels helps in timely intervention. Another strategy is adding more margin (also known as margin top-up) when the position is under pressure. This increases the collateral and pushes the liquidation price further away from the current market price. Using stop-loss orders can also automate the exit before reaching the liquidation threshold. Some platforms offer cross-margin mode, where multiple positions share a single margin pool, increasing flexibility. However, this also means losses in one position can affect others.

Frequently Asked Questions

No, once a position is liquidated, the margin used to open the trade is typically forfeited. Any remaining balance after repaying the borrowed assets and fees may be returned, but in most cases, the entire margin is consumed during the process. There is no mechanism to reverse a liquidation or reclaim lost funds.

Why did my position get liquidated even if the market briefly touched the price?Liquidation is triggered based on the mark price, not the last traded price. The mark price is a fair value estimate derived from external indices and prevents manipulation. If the mark price hits your liquidation level—even momentarily—the system will initiate liquidation regardless of whether the order book price recovers.

Does liquidation always happen at the exact liquidation price shown on the platform?Not necessarily. The displayed liquidation price is an estimate. Actual liquidation may occur slightly above or below due to funding rate adjustments, price volatility, or delay in price feeds. Additionally, during rapid market moves, the execution price may differ due to slippage.

Can I still get liquidated even with sufficient margin in my account?Yes, if the margin is spread across multiple positions and one of them experiences a sharp adverse move, that specific position can still be liquidated even if the total account balance appears healthy. Each position is evaluated independently based on its own margin and leverage settings.