Margin Liquidation

In cryptocurrency trading, margin liquidation refers to the phenomenon where investors engaging in leveraged trading (such as isolated margin, cross margin) have their positions forcibly closed by the exchange due to reverse market price movements, resulting in the margin in their accounts being insufficient to cover losses. Liquidation can cause partial or all of the investor's principal to be lost, and it is essentially a scenario where the unique risks of leveraged trading concentrate and erupt. The following is a detailed analysis:

I. Core Logic of Liquidation: The Relationship Between Leverage and Margin

1. The Essence of Leveraged Trading Investors amplify their trading size by borrowing funds (such as borrowing coins from exchanges). For example, using 1,000 USDT principal with 10x leverage allows trading of 10,000 USDT worth of assets. However, leverage amplifies both profits and losses.

2. The Role of Margin Margin serves as a "safety cushion" for trading. When market prices move in the opposite direction, losses are first deducted from the margin. If the margin is insufficient, liquidation is triggered.

II. Trigger Conditions for Liquidation: Margin Ratio Drops Below the Liquidation Line

1. Key Indicator: Margin Ratio Margin Ratio = (Account Net Value (Principal + P&L) / Value of Borrowed Funds) × 100%

   • When the margin ratio falls below the exchange-set maintenance margin ratio (e.g., 5%, 10%), the liquidation mechanism is triggered.

2. Case Illustrations

   • Long Position Liquidation: An investor uses 1,000 USDT principal and 10x leverage to buy 10,000 USDT worth of BTC (assuming the price is 50,000 USDT/BTC, holding 0.2 BTC). If BTC falls to 40,000 USDT:

     • Asset value becomes 0.2 BTC × 40,000 = 8,000 USDT

     • Borrowed funds: 9,000 USDT (10,000 - 1,000 principal)

     • Account net value = 8,000 - 9,000 = -1,000 USDT (principal fully lost, owing 1,000 USDT)

     • Margin ratio = (-1,000)/9,000 ≈ -11.1% (far below the maintenance margin ratio, leading to liquidation).

   • Short Position Liquidation: An investor borrows 0.2 BTC (worth 10,000 USDT) for shorting, with a principal of 1,000 USDT. If BTC rises to 60,000 USDT:

     • Need to repay 0.2 BTC, valued at 0.2 × 60,000 = 12,000 USDT

     • Account net value = 10,000 (proceeds from selling) + 1,000 (principal) - 12,000 = -1,000 USDT

     • The margin ratio is negative, triggering liquidation.

III. Types of Liquidation: Classified by Leverage Models

1. Isolated Margin Liquidation

   • Only the margin of a specific position is consumed, and other assets are unaffected. For example, the liquidation of an isolated BTC margin account does not affect an isolated ETH margin account or spot assets.

2. Cross Margin Liquidation

   • All leveraged positions share the margin. If one position incurs excessive losses, it may lead to the liquidation of all assets (such as chain liquidation).

IV. Process and Consequences of Liquidation

1. Exchange Liquidation Mechanism

   • Warning Stage: When the margin ratio approaches the maintenance margin ratio, the exchange will prompt for additional margin or position reduction.

   • Forced Liquidation: If no timely action is taken, the exchange will sell/buy assets at market price or limit order, using the transaction funds to repay the loan and interest.

   • Liquidation Gap Risk: If the liquidation price fluctuates sharply and the transaction amount is insufficient to cover the loan (such as a "liquidation gap"), investors may need to make additional compensation (some exchanges have insurance funds to cover this).

2. Investors' Losses

   • After liquidation, the principal may be fully lost, and in the case of a liquidation gap, investors may owe funds to the exchange (in extreme cases).

   • Example: After a 1,000 USDT principal is liquidated, if only 800 USDT is recovered from the liquidation, and 1,000 USDT needs to be repaid, the loss is 200 USDT (principal fully lost).

V. Main Causes of Liquidation

1. Blindly Chasing Trends with High Leverage

   • With leverage above 10x, a 10% price fluctuation may lead to liquidation (as the maintenance margin ratio for 10x leverage is typically 5%–10%).

2. No Stop Loss or Risk Control Set

   • Lack of discipline, failing to manually close positions when losses reach a certain percentage, allowing risks to expand.

3. Sharp Market Fluctuations or Wicks

   • The cryptocurrency market trades 24 hours a day. Sudden news (such as policy regulation, project black swans) may cause prices to crash/soar instantly (such as "wicks"), leading to liquidation before timely action can be taken.

4. Unreasonable Fund Management

   • Full-position trading (such as using 100% principal for leverage) leaves no buffer for price fluctuations.

VI. How to Avoid Liquidation?

1. Control Leverage Multiples

   • Novices are advised to use 2–5x leverage, and even senior investors should not exceed 10x. For example, with 10x leverage, a 10% reverse price movement is close to the liquidation line.

2. Reserve Sufficient Margin

   • Maintain the margin ratio at a high level (such as above 30%) to avoid triggering risks due to minor fluctuations.

3. Set Stop Loss and Take Profit

   • Use the exchange's "take profit/stop loss" function to automatically close positions when the price reaches the preset level, locking in losses.

4. Diversify Positions and Avoid Heavy Positions in a Single Currency

   • Do not invest all funds in the leveraged trading of a single currency, reducing the impact of fluctuations in a single asset.

5. Pay Attention to Market Risk Events

   • Avoid high-volatility periods before and after major events (such as Federal Reserve interest rate decisions, project upgrades), or reduce leveraged positions.

VII. Differences Between Liquidation and Spot Trading

Trading Type	Liquidation Risk	Loss Ceiling	Suitable for
Leveraged Trading	Exists liquidation risk	May exceed principal (liquidation gap)	Those with strong risk tolerance and rich experience
Spot Trading	No liquidation risk	Maximum loss is all principal	Ordinary investors, long-term holders

Conclusion

Liquidation is the "double-edged sword" risk of leveraged trading—it can amplify profits but also wipe out principal in an instant. The core reason is that margin cannot cover the excessive losses brought by leverage, essentially a lack of risk control. For ordinary investors, it is recommended to first familiarize themselves with spot trading, then cautiously try low-leverage trading, and must do a good job in fund management and risk warning to avoid asset losses due to liquidation.