What is liquidation in crypto? Liquidation price explained

In crypto, liquidation means an exchange or protocol automatically closes your leveraged position, or sells your collateral, because your losses have used up almost all the money backing it. It is the reason headlines report "$800 million liquidated" after a sharp move. This guide explains what triggers a liquidation, how to estimate a liquidation price, why liquidations snowball, and how traders reduce the risk. It is educational and not investment advice.

Why liquidation exists

When you trade with leverage, for example on perpetual futures, you put down collateral called margin and the exchange lets you open a bigger position. With 10x leverage, $1,000 of margin controls a $10,000 position. The exchange is effectively lending you the difference, and it needs a way to make sure your losses never exceed what you deposited.

That safety valve is liquidation. Every position has a maintenance margin, a minimum amount of equity it must keep. If the price moves against you and your equity drops to that level, the exchange's risk engine takes over and closes the position, usually at or near a liquidation price shown when you open the trade. Most venues use a mark price, built from an index of spot prices on several exchanges, rather than the last trade, so one odd print does not wipe people out.

A worked example

Take a simplified long on bitcoin, ignoring fees and funding:

• Bitcoin is at $80,000. You post $1,000 of margin at 10x, so you control $10,000, or 0.125 BTC.
• Each $1 fall in bitcoin costs you $0.125. A drop of $8,000, or 10%, would erase the full $1,000.
• Suppose the maintenance margin is 0.5% of the position, or $50. You are liquidated once losses reach $950, which happens at about $72,400, a fall of roughly 9.5%.

Now run the same trade at 50x: $200 of margin controls the same $10,000. Losses of $150 leave you at the $50 maintenance level, so the liquidation price is about $78,800, a drop of only 1.5%. Bitcoin can move that much in an hour. Real liquidation prices also shift with trading fees, funding payments and the exchange's tiered margin rules, so always read the number your exchange shows rather than working it out by hand.

Isolated vs cross margin

How much you can lose in a liquidation depends on the margin mode.

Cross margin can keep a position alive longer, because spare funds act as a buffer, but that buffer is the rest of your money.

Liquidation cascades

Liquidations are not just individual events. When many traders hold leveraged positions on the same side, their liquidation prices tend to cluster just below obvious levels such as round numbers. A drop into that zone triggers the first liquidations, and the engine sells those positions into the market. That selling pushes the price lower and reaches the next cluster. This is a liquidation cascade, and it works in reverse too: forced buying from liquidated shorts is called a short squeeze.

Cascades explain why crypto prices can fall far faster than news alone would suggest. Our coverage shows how often they happen: nearly $1 billion was liquidated on Oct. 15, $404 million of longs were wiped out in four hours on Oct. 24, and CoinGlass data counted more than $800 million in 24 hours as bitcoin returned to $80,000 ahead of Fed week. Data sites also publish "liquidation heatmaps" that estimate where clusters sit, though these are models rather than exact maps.

Insurance funds and auto-deleveraging

In fast markets the engine sometimes cannot close a position before the price passes the point where your margin covers the loss. The shortfall has to come from somewhere. Most large exchanges keep an insurance fund, partly built from the leftover margin of orderly liquidations, to absorb it.

If the fund is not enough, some exchanges use auto-deleveraging (ADL). They close part of the most profitable, most leveraged positions on the other side of the trade at the bankruptcy price. That means even winning traders can be cut out of a position during extreme moves. Exchanges usually show your place in the ADL queue as a small indicator.

Liquidation in DeFi lending

Decentralised lending apps such as Aave or Compound liquidate too, in a different way. You deposit crypto as collateral and borrow against it, for example ether against stablecoins. Each loan has a safety measure, often called a health factor. If your collateral falls in value and that measure drops below the threshold, anyone can act as a liquidator. They repay part of your debt and receive some of your collateral at a discount, called a liquidation bonus. You keep the loan but lose more collateral than the debt that was repaid. Our guide to DeFi covers how these protocols work.

How traders reduce liquidation risk

• Use lower leverage. At 2x or 3x a position survives moves that would liquidate a 20x trade many times over.
• Prefer isolated margin for single trades so one mistake cannot drain your account.
• Set a stop-loss above your liquidation price. Leaving on your own terms usually costs less than a forced close and its fees.
• Watch funding and fees on long holds, since they slowly erode margin and move the liquidation price closer.
• Be careful around big events such as central bank decisions and weekends, when liquidity is thin.