Liquidation – Definition:
Liquidation refers to the process of converting a cryptocurrency or asset into fiat currency or stablecoins, either voluntarily or under forced circumstances. This term is particularly relevant in the context of cryptocurrency trading and investment.
In forced liquidation, which often occurs in margin trading, a trader’s position is automatically closed when it fails to meet certain predetermined conditions. Margin trading involves borrowing funds to amplify trading positions, and higher leverage can result in a narrower liquidation price range. For instance, if a trader wants to margin trade BTC/USDT with limited capital and high leverage, a small price dip can lead to the lender converting their Bitcoin (BTC) to USDT to recover their share of the investment, triggering the liquidation of the trader’s position. Some platforms charge a fee for forced liquidation.
Voluntary liquidation, on the other hand, occurs when a trader decides to cash out their cryptocurrency assets willingly, often due to personal reasons or as a strategic move.
Types of Liquidation:
- Partial Liquidation: This involves selling a portion of the trading position to prevent total loss. Partial liquidation is typically voluntary but can also be initiated under predefined agreements, even before the trader’s initial capital is fully depleted, to avoid additional liquidation fees.
- Total Liquidation: Total liquidation entails selling the entire trading balance to offset losses. It mainly occurs in forced liquidation when the lender forcefully closes a position to safeguard their own capital. In this scenario, the trader incurs a complete loss of their invested capital and may end up with negative balances.
Liquidation is a crucial concept for traders and investors to understand, as it directly impacts risk management and financial outcomes in the cryptocurrency market. Traders should carefully consider leverage, margin requirements, and the potential for liquidation when engaging in leveraged trading activities.