What Happens When You Get Liquidated in Crypto?

Imagine you wake up, check your phone, and realize your entire crypto portfolio is gone—liquidated overnight. The shock hits you, but the real pain comes from knowing you were this close to avoiding it. Liquidation isn’t just a loss; it’s the system reclaiming what you borrowed, with brutal precision. Here’s how it works, why it happens, and how to avoid it in the future.

Let’s dive in.

What is Liquidation in Crypto?

When you borrow money or crypto to invest in a leveraged position, you put up collateral. This collateral is a safeguard for the lender (which is often the platform or exchange) in case your trade doesn’t go as planned. If the market moves against you and the value of your collateral drops below a certain threshold, the platform will liquidate your position. In simpler terms, they will sell your assets to cover the debt you owe.

It's like this: Imagine you’ve got $10,000 worth of Bitcoin and you borrow $5,000 from a platform like Binance or FTX to trade more Bitcoin. If the price of Bitcoin drops significantly, the platform will automatically sell your Bitcoin to ensure they don’t lose any money.

Sounds harsh, right? Well, that's the nature of leveraging.

How Does It Work?

• Leverage: You borrow funds to increase the size of your trade. Instead of just using the assets you own, you amplify your buying power.
• Collateral: You need to provide a portion of your assets (crypto) as collateral for the borrowed funds. This collateral is what keeps your position alive.
• Margin Call: If the market price of the asset you’re trading drops too low, you’ll get a margin call—basically, a warning that you need to add more collateral to avoid liquidation.
• Liquidation: If you don’t add more collateral or the price continues to fall, the platform will automatically sell off your assets to recover the borrowed funds.

The Emotional Toll of Liquidation

If you’ve ever been liquidated, you know how it feels: heart pounding, stress through the roof, and a sense of helplessness as you watch your funds disappear. Liquidation is fast, and it doesn’t care about your emotions. It’s a financial algorithm doing its job, and once it’s triggered, there’s no turning back.

Why Liquidations Happen

1. Leverage Gone Wrong: Most traders use leverage to amplify their positions, but leverage is a double-edged sword. While it can magnify your gains, it also magnifies losses. A 10% drop in price could wipe out your entire position if you’re over-leveraged.

2. Volatility: Crypto markets are highly volatile, meaning prices can swing dramatically in a short amount of time. Even a slight dip in price can trigger liquidation if you’re not careful.

3. Inadequate Risk Management: Many traders fail to implement proper risk management strategies like stop-loss orders, which can protect you from getting liquidated.

4. Overconfidence: This is where human psychology plays a role. Many traders become overconfident, especially in bull markets, thinking that prices will continue to rise indefinitely. When the market corrects, these traders are often caught off-guard.

The Domino Effect of Liquidation

Here’s where things get even more interesting: liquidations can cause a chain reaction. When a large number of leveraged positions are liquidated in a short time, it can trigger a cascade of liquidations across the market. This results in a sharp drop in prices, which causes more positions to be liquidated. It’s like a snowball rolling down a hill—small at first, but quickly growing into an avalanche.

The crypto markets have seen several of these liquidation cascades, especially during periods of high volatility. These events can lead to massive losses for traders and further destabilize the market.

How to Avoid Liquidation

1. Lower Leverage: The simplest way to avoid liquidation is to reduce your leverage. Instead of borrowing 10x your initial investment, consider borrowing 2x or 3x. This reduces the chances that a small dip in the market will wipe out your position.

2. Use Stop-Loss Orders: A stop-loss order is a tool that automatically sells your position if the price drops to a certain level. This can prevent your position from being liquidated by allowing you to exit before the collateral is at risk.

3. Monitor Your Position: Always keep an eye on the market and your position. Set alerts for price movements and be ready to add more collateral if necessary.

4. Diversify: Don’t put all your eggs in one basket. By spreading your investments across multiple assets, you reduce the risk of one asset’s price crashing and liquidating your entire portfolio.

Real-Life Stories of Liquidation

Let’s look at some real-world examples.

In May 2021, the crypto market saw a massive crash, with Bitcoin dropping from $64,000 to $30,000 in a matter of days. This crash resulted in over $8 billion in liquidations. Thousands of traders, many of whom were over-leveraged, lost their entire portfolios.

Another example is the infamous FTX liquidation crisis in 2022, where the platform faced liquidity issues, and many traders were liquidated as a result. The impact on individual traders was devastating, with some losing millions in a single day.

These events show just how brutal the crypto market can be, especially for those using leverage without proper risk management.

How Liquidations Impact the Market

Liquidations don’t just affect individual traders—they can have a ripple effect on the entire market. When large amounts of assets are sold off during liquidations, it can lead to rapid price declines, further destabilizing the market. This is why we often see sharp drops in prices during major liquidation events.

Moreover, liquidation events can shake investor confidence, causing more people to sell off their assets, leading to further price drops.

Conclusion: How to Thrive in a Volatile Market

The truth is, liquidations are a natural part of the crypto ecosystem. They act as a balancing mechanism, ensuring that leverage doesn’t spiral out of control. However, they can be devastating for individual traders who are caught off-guard.

The key to avoiding liquidation lies in understanding the risks and implementing proper risk management strategies. By lowering leverage, using stop-loss orders, and staying informed about market movements, you can significantly reduce your chances of being liquidated.

Remember, the crypto market rewards patience and discipline. While leverage can be tempting, it’s not worth risking your entire portfolio for a short-term gain. Keep your emotions in check, stay informed, and always prioritize risk management over potential profits.