What Is Forced Liquidation?

Liquidation means selling assets for cash. Forced liquidation means that this process happens automatically once certain conditions have been met. In regards to crypto, forced liquidation is when investors or traders cannot meet the margin requirements necessary for a leveraged position. So what else is there to know about forced liquidation? Keep reading.

Forced Liquidation: The Basics

The involuntary conversion of assets into cash or cash equivalents (i.e., stablecoins) is forced liquidation. The term simply translates to an asset holder having to sell their assets for cash, and this selling happens automatically once specific conditions have been met. The mechanism creates market orders to step away from leveraged positions.

When trading with leverage, the liquidation price is something you’ll need to keep checking on.

Here’s an example:

You begin with $50 and enter a leveraged long position in the BTC/USDT market with 10x leverage, meaning your position size is $500—the total consists of your initial $50 plus the remaining amount borrowed.

So what would happen if Bitcoin were to drop about 10% or so? The position would drop to $450. Incurring further losses would then apply to the borrowed portions of funds—take a look at our post on crypto margin lending. Lenders typically don’t feel comfortable risking a loss on someone else's behalf, so the next move would be liquidating your position to protect their capital. When the position is closed, you not only lose the loan, but you also lose your original $50 investment

Not only that, but exchanges usually charge liquidation fees (not to be confused with liquidity mining). The goal behind liquidation fees is to encourage traders to close their positions before automatic liquidation occurs. Something to remember is that leverage cuts both ways. High leverage will make you extra money when trades go as planned but only require a slight negative shift to trigger liquidation. So a trade position with 50x leverage would only require a change of 2% to initiate the liquidation process.

Summary of Important Points

• Forced liquidation is used to protect lenders’ capital.
• Keep a close eye on liquidation price.
• More leverage used = closer liquidation price.
• When a position is closed, you lose your investment plus the loan.
• Market volatility can be the cause of initiating automatic liquidation.
• Even small negative shifts can initiate forced liquidation.

How Long Does Forced Liquidation Take?

During the liquidation process, the liquidation engine takes control of your account and periodically sends orders in the market to close your position.

The goal of the automatic liquidation engine is to carefully close positions in the market and keep the impact to a minimum. The engine also sends standard limit orders on behalf of the account being liquidated.

The speed of forced liquidation depends on the position size, but in regards to smaller positions, it aims to close them down within a minute or so.

How Much Does Forced Liquidation Cost?

Liquidation costs are calculated based on the trader’s selected leverage, maintenance margin, and entry price. There are some calculators online that can be used to estimate liquidation costs.

How do you calculate the forced liquidation value?

To determine the value of a business undergoing forced liquidation, an appraiser would usually estimate the value of each asset for a grand total. FLV is the total amount of money that would be received after selling the assets.

How Can Forced Liquidation Be Prevented?

Insurance funds can act as a safety net, protecting bankrupt traders from undesirable losses. Using liquidation exit strategies is the best way to prevent forced liquidation, to begin with. Exit plans minimize loss.

Stop-Loss

Using a stop-loss order translates to the trader closing their position with a market order. Once the last traded price reaches a predetermined price is when stop-loss occurs. This method also provides traders with an extra layer of protection, limiting potential loss that crosses the entry price.

Trailing Stop-Loss

This tool is a stop-loss order that triggers a trailing stop once the last traded price peaks and moves only in one direction. This technique also minimizes loss and increases unrealized gains when the market moves in your favor.

Reducing leverage is also a way to combat forced liquidation. Although, the first and most critical step is keeping track of liquidation prices and how close your positions are to not covering margin.

Can You Take Legal Action After Forced Liquidation?

If you’ve experienced forced liquidation, there may be legal action that you can take against a broker-dealer. Depending on what occurred when your financial advisor recommended the security-backed line of credit or margin accounts, you may have an opportunity to recover your investment losses.