Liquidation is a commonly discussed topic in the world of cryptocurrency, but it’s crucial to have a clear understanding of its meaning and how to avoid it.
Simply put, liquidation is the act of selling assets to fulfil financial obligations or pay off debt. In the context of crypto, it can occur when a trader’s margin account balance dips below a certain threshold, resulting in the exchange selling off their assets to cover the loss.
To help you navigate this topic with ease, this article will provide a brief overview of what liquidation is and how you can avoid it.
What is liquidation?
Liquidation is the practice of selling off assets to pay off debts or other financial obligations. In the world of cryptocurrency, liquidation refers to the selling of large amounts of digital currency in order to pay off a margin debt or prevent a trade from losing too much value. This can occur on cryptocurrency exchanges when a trader has borrowed money to make a trade and the value of that trade decreases. To repay the borrowed funds, the exchange will sell the trader’s assets, a process known as a “liquidation event.”
Understanding margin trading
To fully grasp the concept of liquidation, it is crucial to first understand margin trading.
Margin trading facilitates traders to right to use additional funds for trading beyond the amount currently in their account. This is achieved by borrowing money from the exchange to trade with. The trader then must pay back the borrowed money, along with interest, when they close the trade.
When engaging in margin trading, traders are obligated to keep a specific amount of their own funds in their account as collateral. This is referred to as the minimum margin requirement or maintenance margin. If the cost of the trader’s assets drops below the margin requirement, their account will be liquidated.
What causes liquidation?
There are a few factors that can cause liquidation in a crypto margin trading account. The most common cause is a sudden drop in the value of the assets in the account. For example, if a trader has bought a large amount of Bitcoin on margin, and the value of Bitcoin drops significantly, their account may be liquidated to cover the loss.
Another trigger for liquidation is when a trader’s account balance goes below the minimum required maintenance margin. This can happen if the trader does not deposit more money into their account or if they lose a large amount of money on a trade.
How you can avoid liquidation?
There are several ways to avoid liquidation in a crypto margin trading account. The key is to always ensure that your account balance is kept at a sufficient level. This means keeping enough of your own money in the account to meet the maintenance margin requirement.
It is also substantial to keep an eye on the worth of the resources in your account. If the value of your assets starts to drop, it is best to close your position and take the loss rather than risk a liquidation.
Another way to avoid liquidation is to limit your leverage. It is the sum of money you are borrowing from the exchange to trade with. The greater the leverage, the greater the likelihood of being forced to sell assets. By limiting your leverage, you are reducing the risk of liquidation.
Conclusion
Liquidation is a serious risk in crypto margin trading, but it is something that can be avoided. By understanding the concept of margin trading and the causes of liquidation, traders can take steps to protect their assets and avoid the risk of liquidation. By maintaining a healthy balance in your account, keeping an eye on the value of your assets, and limiting your leverage, you can reduce the risk of liquidation and trade with confidence.
