What Is Liquidation?
Also known as: Forced Liquidation, Position Liquidation, Forced Position Closure
In short
Liquidation is the forced closing of a position by an exchange or protocol when the value of the collateral in a leveraged trade or collateralized loan falls below a set threshold, resulting in partial or total loss of the collateral.
In futures and margin trading, the investor posts collateral (margin) to keep a position open. As the price moves against the position, losses are deducted from this collateral; when the collateral drops to the maintenance margin level set by the exchange, the liquidation price has been reached and the system closes the position automatically. For example, in a long position opened with 10x leverage, a drop of roughly 10% in price, not counting fees, wipes out all of the collateral; for this reason, liquidation occurs before that point is reached.
A similar mechanism operates in DeFi lending protocols. The user borrows against the collateral they deposit; if the collateral ratio falls below the limit set by the protocol, participants called liquidators can repay part of the debt and buy the collateral at a discount. This system prevents the protocol from accumulating bad debt.
Sudden price moves can trigger cascading liquidations: forced closures increase selling pressure, which in turn triggers new liquidations. High leverage raises risk significantly because it brings the liquidation price closer to the current price.
Last updated: · This content is for information purposes only and is not investment advice.