Liquidation
In simple terms
Liquidation is when an exchange automatically closes your investment position because you've lost too much money. It's like a lender taking back collateral when you can't pay back a loan.
Definition
Forced closure of a leveraged position when losses exceed margin.
In depth
Liquidation occurs when a trader's leveraged position is forcibly closed by the exchange or protocol when the account equity falls below the maintenance margin requirement. The mechanism monitors the mark price (often derived from oracle feeds) against the trader's collateral in real-time; once losses accumulate such that remaining margin cannot cover potential further losses, liquidators—incentivized by a liquidation bonus—execute the position closure through an automated smart contract. This process protects the protocol from insolvency by ensuring positions are exited before losses exceed available collateral.
How does Liquidation work?
The exchange compares account equity against the maintenance margin requirement using a mark price. When equity falls to that level, the account is flagged and the platform's liquidation engine takes over: it cancels the account's open orders, then force-closes the position into the market or hands it to a liquidation mechanism, usually charging a liquidation fee. Remaining collateral absorbs the realized loss and the fee. If the position closes worse than its bankruptcy price because of a price gap or thin liquidity, an insurance fund or auto-deleveraging covers the shortfall.
An example
Someone opens a $5,000 long backed by $500 of collateral at 10x, on a platform with a 0.5% maintenance rate — $25 — using illustrative figures. An adverse move of roughly 9.5% erases $475, leaving $25 of equity and triggering liquidation. The position is force-closed, a fee is deducted, and little or none of the original $500 remains. That loss is realized and permanent.
Figures are illustrative only.
What beginners get wrong
- Liquidation closes a position at whatever price the market provides, which is not the same as a stop-loss set deliberately.
- The liquidation price shifts over time as funding payments and fees are deducted from collateral, so it is not fixed at entry.
- Trying to add collateral during a fast move often fails, because liquidation runs automatically and can complete within seconds.
- On platforms without negative-balance protection, a violent price gap can leave an account owing more than the collateral posted.
Related terms
Part of
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Educational only — not financial advice.