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Crypto Liquidation Meaning

Jul 26, 2023 | Updated Jul 26, 2023
Liquidation in crypto refers to the process of converting assets, typically leveraged positions or collateral, into cash to cover losses or repay borrowed funds when the market moves unfavorably.

What is Crypto Liquidation?

Crypto Liquidation refers to closing a trading position by converting a cryptocurrency asset to fiat currency or stablecoins. Trades are typically executed at levels that are less favorable than the current market price.

Liquidation, in the context of futures trading, is common in situations where a trader borrows money to improve their exposure to a trading position. It happens when a trader has insufficient capital to keep the position open or as an attempt to minimize losses. It can be either voluntary or involuntary (forced). 

Voluntary liquidation occurs when the trader decides to cash out their cryptocurrency from a losing trade or for their own reasons. On the contrary, forced liquidation happens when the lender (the crypto exchange, smart contract, or broker) forcefully closes the trader’s position to prevent further losses and protect their capital. 

In some cases, liquidation occurs before the initial capital is depleted.

What are Types of Liquidation?

There are two main types of crypto liquidation, which differ mainly in the extent to which a trading position is closed. It can either be partial liquidation or total liquidation.

Partial liquidation

A partial liquidation involves cashing out to prevent losing the entire trading stake. Thus, it occurs before the initial margin is depleted. It is usually voluntary. However, it can be forced based on the predefined agreement between the trader and the lender. In such a case, the position is closed before the initial capital is depleted to offset an extra liquidation fee.

Total liquidation

Total liquidation involves selling off an entire trading balance to offset losses. It often occurs in forced liquidation when the lender is forced to close a position to prevent losing their capital. The trader, however, loses their entire invested capital and may end up with negative balances.

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