What Is Liquidation in Crypto? Understanding Forced Closures in Trading

Crypto liquidation is the forced closure of a leveraged trading position when losses reduce your collateral below the exchange’s required margin. It protects the platform from bad debt but often wipes out most or all of the trader’s funds.

This isn't some vindictive punishment or a rug pull; it’s a built-in safety mechanism that exchanges use to ensure borrowed funds are repaid. For traders, though, it often feels like the rug was yanked out from under them. 

If you're using any leverage in crypto (or even contemplating it), you'll want to read on to know exactly how this works and how to protect yourself.

What You’ll Learn About Forced Crypto Liquidation 

The exact mechanics behind liquidation - why exchanges close your positions automatically and how the process unfolds step-by-step.

How to calculate your liquidation price before opening any trade - the simple math that determines exactly when your position dies.

Warning signs that liquidation is approaching - market conditions and margin ratios that signal danger before it's too late.

Real examples from major liquidation events - how billions in leveraged positions got wiped out during crashes like Black Thursday and the 2025 Trump tariff panic.

Practical prevention strategies that actually work - position sizing, risk management, and monitoring techniques used by traders who survive volatile markets.

What Is Liquidation in Crypto Trading?

Liquidation is the automatic closure of your leveraged position when losses reduce your account balance below the minimum required to maintain that position. 

It’s the exchange's emergency brake. When your trade goes too far south, the platform steps in and forces you out before things get worse. Liquidation is their way of keeping the books balanced.

The Basic Definition

Liquidation happens when:

• You open a leveraged position using collateral (your margin).

• The market moves against you, eroding that collateral.

• Once your margin falls below the required level, the exchange closes the trade automatically.

It’s not optional, and you don’t get to decide the timing. By the time liquidation kicks in, your position is gone. Sometimes a small balance remains after fees; often, it’s close to zero.

Why Liquidation Exists

Exchanges didn't create liquidation systems to torture traders. They're protecting themselves and maintaining market stability. Without liquidation, traders could theoretically owe exchanges millions of dollars they don't have, especially during flash crashes or extreme volatility events.

Liquidation also protects other traders. When someone is liquidated, their position is closed at current market prices, providing liquidity for other market participants. It's harsh for the individual trader, but it keeps the broader system functional.

The Mechanics: How Crypto Liquidation Actually Works

Liquidation follows a predictable process, and once you know how it works, you can spot the warning signs before your position gets closed out.

Margin and Maintenance Requirements Explained

Every leveraged position revolves around two numbers that determine whether you stay in the game or get kicked out:

Initial margin is what you put down to open your position. Say you want to control $10,000 worth of Ethereum with 4x leverage—you'll need $2,500 as your initial margin.

Maintenance margin is where things get serious. This is the minimum amount your account needs to keep that position alive. Most exchanges set this somewhere between 10-20% of your total position size, but it varies depending on which platform you're using and what you're trading.

Your margin ratio tells you how close you are to liquidation. It's simply your current account balance divided by your position size. When this drops below the maintenance threshold, the exchange's liquidation engine kicks in automatically.

If margin trading still seems confusing, our complete margin trading guide explains position sizing, leverage ratios, and risk management in more detail.

The Liquidation Process Step-by-Step

Here's what actually happens when your trade goes sideways:

1. Position goes underwater: The market moves against you, and your margin drops below what the exchange requires.

2. Margin call warning: Some platforms will ping you, but plenty don't bother(never count on getting a heads up).

3. Grace period: You might get a few minutes to add more funds or cut your position size, but sometimes you get seconds.

4. Liquidation trigger: The exchange's system takes over your position completely.

5. Market order execution: Your position gets dumped at whatever price buyers are willing to pay right now.

6. Fee deduction: The platform grabs its liquidation fee from whatever's left in your account.

7. Settlement: Any remaining scraps get returned to your balance (don't get your hopes up).

This whole sequence can play out faster than you can refresh your browser.

How Liquidation Price Gets Calculated

Every leveraged position has a liquidation price baked in from the moment you open it. This is the exact price level where your position dies, no matter what.

Let’s say you go long on $8,000 worth of Solana at $200 per token using 5x leverage. You’re putting up $1,600 of your own money and borrowing $6,400 from the exchange, giving you control of 40 SOL.

If the maintenance margin requirement is 15%, your liquidation price sits around $190. That’s only a 5% drop from where you entered

You should calculate this number before you even think about opening a position. If your liquidation price is uncomfortably close to the current market price, you're basically gambling that normal market volatility won't touch you. 

News flash: it probably will.

The math behind liquidation isn't some mystery algorithm. It's straightforward arithmetic, which means you can control your risk by knowing these numbers ahead of time.

Famous Crypto Liquidation Events

Liquidation events don't happen in isolation; they cascade. When the market moves fast enough, individual liquidations pile up and create selling pressure that triggers even more liquidations. Here's how some of the biggest crashes played out.

The March 2020 "Black Thursday" Massacre

Bitcoin crashed 50% in a single day during the COVID panic. Over $1 billion in leveraged positions got liquidated across all platforms as traders watched their "conservative" 5x leverage positions disappear overnight.

Platform overloads made everything worse, with some exchanges unable to process liquidations fast enough, which meant traders lost even more money than they should have.

The lesson: external events can trigger liquidation cascades that wipe out positions regardless of your leverage ratio.

The May 2021 China Mining Ban Cascade

When China announced mining restrictions, Bitcoin dropped 30% in hours. $8.6 billion in leveraged positions got liquidated in 24 hours. Even traders using just 2x leverage got wiped out during the panic selling.

This crash showed how regulatory news creates instant, massive volatility. No amount of technical analysis could have predicted the timing or severity of China's announcement.

The FTX Collapse Liquidation Chaos (November 2022)

The FTX implosion created massive selling pressure that triggered liquidations across all platforms, not just FTX itself. Traders on "safe" exchanges got liquidated because the market-wide panic drove prices down everywhere.

Many overleveraged positions created cascading liquidations where one liquidation triggered the next in a vicious cycle. 

The February 2025 Trump Tariff Crash

The largest liquidation event of 2025 occurred when Trump announced aggressive trade tariffs. In 24 hours, 729,073 traders were liquidated, with total losses reaching $2.23 billion. As panic selling spread, the crypto market lost $400 billion in total market cap.

Ethereum traders actually took a bigger hit than Bitcoin traders, losing over $600 million in leveraged positions. 

The Liquidation Death Spiral Effect

All these events share a common pattern: liquidations create selling pressure, which drives prices lower, which triggers more liquidations. 

Automated systems add to this by dumping positions onto the market all at once, regardless of price impact or order book depth.

This death spiral helps explain why crypto moves so violently during stress periods. Market sentiment is part of it, but it's forced selling from liquidation engines creating momentum that feeds on itself.

Warning Signs: How to Know Liquidation Is Coming

Most liquidations don't happen out of the blue; they leave clues. Watch for these signals that indicate when your position is skating on thin ice.

Monitoring Your Margin Ratio

Your margin ratio is the most important number on your screen when you're leveraged. Most platforms show this in real-time, usually with color coding that tells you exactly how much trouble you're in.

• Green zone: Safe margin levels, typically above 50%. You're comfortable here, but don't get complacent.

• Yellow zone: Caution territory, usually with a 20-50% margin remaining. It's time to start paying attention and maybe reduce your position size.

• Red zone: Liquidation is imminent, below the 20% margin. At this point, you’re living on borrowed time and one bad candle away from being closed out.

Market Conditions That Raise Liquidation Risk

Certain environments crank liquidation risk through the roof:

High volatility periods turn reasonable positions into liquidation magnets. A 10% move might be normal during calm markets, but during volatile periods, that same move can happen in minutes.

Low liquidity conditions create price gaps that can skip right over your liquidation level, meaning you get closed out at even worse prices than expected.

Major news events, such as regulatory announcements, exchange issues, and macroeconomic data, often trigger sudden moves that catch leveraged traders off guard.

Weekend trading typically has lower liquidity, which means smaller orders can cause bigger price swings.

Funding rate extremes indicate an overleveraged market. When funding rates hit 0.1% or higher, it means too many people are long with leverage, setting up for a squeeze.

Exchange Specific Warning Systems

Some exchanges offer margin call alerts via SMS or email, but many don’t. Even those who do can’t always keep up during flash crashes.

Don’t rely on the platform to save you; the responsibility is on you. Which moves nicely on to some practical liquidation prevention strategies.

How to Avoid Liquidation

Getting liquidated isn’t inevitable. Traders who stay in the game the longest usually follow a handful of habits that keep their positions alive when others are wiped out. 

These aren’t glamorous tricks, but they’re the difference between survival and a clean-out.

Position Sizing and Risk Management

The first line of defence is how you size your trades. Putting half your portfolio into a single leveraged bet is asking for trouble. 

A more sustainable approach is to risk just 1–2% of your total capital per trade, enough to give you exposure without putting your whole account on the line.

Leverage ratios also matter. Beginners should rarely touch more than 2x or 3x. It’s better to keep a wide buffer than to flirt with the edge. 

And before you click “confirm,” always calculate your liquidation price. If it sits just a few percentage points below the current market price, you’re betting that everyday volatility won’t catch you. It’s an assumption markets love to prove wrong.

Active Monitoring and Adjustments

Leveraged positions need babysitting. There's no getting around it. Markets move fast, and a position that looked safe in the morning might be on life support by the evening. 

Set price alerts well above your liquidation level so you’re not blindsided. If things turn against you, adding margin or cutting your position size can buy you breathing room when things get choppy.

Stop-losses might seem like the obvious answer, but they're not magic in crypto. During wild moves, your stop could get filled way below where you set it. Better to have one than not, but don't count on it saving you.

The golden rule is never to set leveraged positions and to walk away. The "set and forget" approach works for spot holdings, but leverage requires constant attention. You can't just open a 3x position on Friday afternoon and check back on Monday morning. That's when you wake up to nasty liquidation emails.

Market Timing and Conditions

Finally, timing is everything. Opening a leveraged trade during a period of high volatility or right before a major news announcement is basically volunteering to get liquidated.

Even the best setups can implode when regulators drop surprise bans or geopolitical events jolt the market. 

Liquidations often happen when traders are asleep, and weekends can be especially dangerous with thinner liquidity. Smart traders scale down their leverage or avoid trades altogether during these riskier windows.

What Happens After You Get Liquidated

Getting liquidated isn't a death sentence, but it does sting. Here's what actually happens once the dust settles.

The exchange will send you a notification after the fact, usually an email with details about which position got closed and at what price. Any remaining balance after fees gets returned to your account, though don't expect much. 

Your position is completely gone. There's no "riding it out" or waiting for a recovery. Even if the price bounces back five minutes later, you're watching from the sidelines.

The emotional hit often hurts more than the financial loss. Getting liquidated feels like the market personally targeted you, especially when prices recover shortly after. This is normal - every leveraged trader has been there.

Don’t let it derail your trading completely. Take a step back, analyze what went wrong with your position sizing or risk management, and resist the urge to immediately jump back in with higher leverage to "make it back." That's revenge trading, and it usually makes things worse.

How Exchanges Handle Liquidations

Not all liquidation systems work the same way. The rules your platform uses can be the difference between losing part of a trade and losing everything.

Features to Compare

Partial vs. full liquidation systems make a huge difference. Some platforms liquidate your entire position the moment you hit the threshold, while others use partial liquidations—closing just enough to bring you back above the maintenance margin. Partial liquidations can save you from losing everything during brief price spikes.

Insurance funds provide an extra layer of protection during extreme market conditions. Exchanges like Binance and OKX maintain these funds to cover losses when liquidations can't be executed fast enough. Not all platforms have them, and fund sizes vary dramatically.

Liquidation fees typically range from 0.5% to 1% of your position size, but some exchanges charge more. These fees come out of your remaining collateral after liquidation, so lower fees mean you keep more of what's left.

Centralized vs. Decentralized Platforms

In 99.9% of liquidation cases, you're going to lose your money whether you're on a centralized exchange or using DeFi protocols. The platform doesn't really determine the outcome - it's more about where you feel comfortable trading.

Centralized exchanges have customer support teams and insurance funds. If something genuinely goes wrong with their system during your liquidation, you can at least file a complaint and maybe get somewhere with it.

DeFi trading runs entirely on smart contracts. The upside is you keep control of your private keys and don't have to trust exchange executives with your funds. The downside is zero human oversight with no appeals process.

For traders who prefer having someone to call when things go sideways, centralized platforms make sense. If you're more comfortable with the transparency of smart contracts and want to avoid counterparty risk from exchanges, decentralized platforms might be your thing.

Our guide to CEX vs. DEX compares these approaches in detail. 

The Final Word on Crypto Liquidations

Liquidation isn’t a glitch in the system. It’s the system working exactly as designed. Exchanges protect themselves first, and if you’re trading with leverage, you’re accepting that risk from the start. 

Most retail traders eventually learn this lesson the hard way. A better approach is to learn it before you put money on the line.

At Learning Crypto, we break down the mechanics, psychology, and strategies that separate gamblers from disciplined traders. 

With real-time tools, AI-powered guidance, and a community of people serious about doing crypto right, you don’t have to trade in the dark.

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