Contract Liquidation

In cryptocurrency contract trading, contract liquidation refers to the process where a trading platform force-closes positions or settles them according to rules due to insufficient margin in the user's account or contract expiration. The detailed analysis is as follows:

I. Trigger Mechanisms for Liquidation

1. Forced Liquidation due to Insufficient Margin (Liquidation)

  • Core Logic: When the user's maintenance margin ratio falls below the platform's set threshold (e.g., 0.5%), the platform automatically closes the position to prevent losses from expanding.

    • Maintenance Margin Ratio = (Account Equity / Position Value) × 100%

  • Example: Suppose a user goes long on 100 BTC contracts (valued at 1 BTC) with 10x leverage and a margin of 0.1 BTC. If the BTC price drops by 10%, the account equity falls to 0.09 BTC. The maintenance margin ratio is 0.09/1 = 9% (assuming the platform threshold is 5%), triggering liquidation.

2. Contract Expiration Liquidation

  • Delivery Contracts: Positions are force-closed at the agreed time (e.g., every Friday), and profits/losses are settled based on the index price (the average spot price of multiple exchanges).

  • Perpetual Contracts: No expiration date, but the funding rate is adjusted daily (e.g., 00:00 UTC) to adjust the position costs for long and short sides, preventing significant price deviations from the spot.

II. Liquidation Processes and Rules

1. Automatic Deleveraging (ADL)

  • When extreme market volatility prevents the system from liquidating positions in time, the platform prioritizes automatically reducing high-leverage profitable positions instead of directly liquidating loss-making accounts to minimize the risk of over-collateralization.

  • Application Scenario: During extreme market conditions, such as a sudden BTC rally pushing numerous short positions to the brink of liquidation.

2. Risk Reserves and Contribution

  • Risk Reserves: The platform extracts a fixed percentage (e.g., 0.05%) from each transaction as a reserve to cover liquidation losses.

  • Contribution Mechanism: If risk reserves are insufficient, remaining losses are shared proportionally by profitable users (some platforms have reduced contributions through optimized algorithms).

III. Impact of Liquidation on Users

1. Loss Calculation

  • Liquidation Loss: Typically the full or partial margin (e.g., a loss of 0.01 BTC in the example above).

  • Over-Collateralization Risk: In extreme market conditions, the liquidation price may deviate from expectations, causing losses exceeding the margin, which must be covered by risk reserves or user contributions.

2. Keys to Avoiding Liquidation

  • Control Leverage: Higher leverage increases liquidation risk (e.g., a 1% reverse price movement with 100x leverage may trigger liquidation).

  • Set Stop-Loss Orders: Preset stop-loss prices to close positions proactively before losses expand.

  • Monitor Margin Ratios: Stay vigilant about account risks and add margin or reduce positions promptly.

IV. Liquidation Differences Among Exchanges

Platform
Liquidation Mechanism
Risk Reserves
Contribution Rules

Binance

Isolated/Full Margin Liquidation, ADL Prioritizes Deleveraging

Covers most extreme scenarios

Rare contributions

Bybit

Partial Liquidation

Over $100 million

No contributions since 2023

FTX (Bankrupt)

Inadequate reserves led to user contributions

Misappropriated customer funds caused shortfalls

Ultimately led to bankruptcy

V. Conclusion: Rational Approaches to Liquidation Risks

  • Nature of Contract Liquidation: A necessary mechanism for platforms to control systemic risks, but it may result in user principal losses.

  • Recommended Strategies:

    1. Leverage ≤10x: Novices should avoid high leverage (e.g., 50-100x).

    2. Always Set Stop-Loss: Configure stop-loss orders simultaneously with position opening (e.g., automatic closure at 10% loss).

    3. Diversify Funds: Avoid allocating excessive funds to a single contract.

    4. Monitor Market Conditions: Reduce positions before/after major events (e.g., Fed decisions).

For further analysis of specific platforms' liquidation rules or real-time risk calculations, feel free to provide more details!

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