One of the most common terms that people interested in finance, especially with cryptocurrencies, hear is “liquidations.” Traders often come across this term, which can cause confusion when its meaning is not known. In this article, we’ll look at what crypto liquidations are.
What is Crypto Liquidations? Everything You Need to Know About Crypto Liquidations 2023
The forced closing out of all or a portion of the initial margin position by a trader or asset lender is known as a liquidation. When a trader is unable to satisfy the allocation of a leveraged position and does not have enough money to keep the transaction running, liquidation occurs.
A leveraged position is when you use your existing assets as collateral for a loan or borrow money. Then you combine the principal from the loan with the principal you previously promised to buy financial products to increase your profit.
Types of Liquidation
The degree to which your trading positions are closed out distinguishes the two types of liquidation the most. They also apply to both forced and voluntary liquidations.
Partial Liquidation
In order to lessen your exposure to risk, partial liquidation means shutting out a portion of your position. Typically, a trader chooses to liquidate his position voluntarily so as not to lose all of his/her trading capital.
Total Liquidation
Selling your whole trading balance to pay losses is known as total liquidation. Typically, it happens when a trader doesn’t meet the margin call requirement, which might result in forced liquidations. The exchange will immediately close down the trader’s holdings to make up for the losses in such circumstances.
Liquidation could result in a negative balance in some serious circumstances. One of the most common strategies used by several exchanges to compensate for these losses is to settle them using insurance funds.
Insurance Funds
Some cryptocurrency exchanges employ several strategies, including using insurance funds, to offset losses from bankrupt positions. Exchanges are protected by these funds, which give them the ability to pay out losses and set aside enough money to reward profitable traders. In the event of bankruptcy, the insurance money will be utilized to cover the loss when the liquidation price exceeds the initial margin, protecting cryptocurrency traders from developing a negative balance.
How Can Liquidation Be Avoided?
There are certain techniques you can use to lessen the threat of liquidation.
Calculating Risk Percentage
It’s crucial to decide how much money you can afford to lose and how much of your trading account you’re willing to risk on each trade. According to experts, you shouldn’t put more than 1% to 3% of your account at risk in one transaction.
Monitoring Futures Open Interest (OI)
Keep an eye on the futures open interest on the exchange you trade on, as historically high open interest occasionally signals that the market is overly leveraged. These positions may be liquidated at times of market stress, setting off a chain reaction that could even result in a flash crash, which has happened frequently in the brief history of cryptocurrencies.
Using a Stop-Loss Order at All Times
A stop-loss order might be beneficial while trading to limit the amount of money you might lose if the market performs poorly. For example, if you create a stop-loss order at 5% below the entry price, any possible losses if the transaction doesn’t work out will be limited to that amount.
On the other hand, without a stop-loss order, losses can escalate out of control. It may cause you to lose a lot of money or perhaps all of your trading funds because the cryptocurrency market can be extremely unpredictable and volatile for a variety of reasons.
Leave a comment