What is Forced Liquidation?
Let's find out Forced Liquidation meaning, definition in crypto, what is Forced Liquidation, and all other detailed facts.
Liquidation refers to the conversion of assets into cash or cash equivalents. The compulsory conversion of assets into cash is known as forced liquidation. It's a system for generating market orders to exit leveraged positions. The difference between liquidation and forced liquidation is that the latter occurs automatically when certain requirements are met (or not).
In the crypto world, when an investor doesn’t fulfill the margin requirements for a leveraged position, forced liquidation occurs. Liquidation applies to both – futures and margin trading.
Keep in mind that liquidation price is something you should pay attention to when trading with leverage. If your leverage is high, the liquidation price is very close to your entry.
To illustrate, imagine that you begin with a $100 deposit. Let’s say you take a 15x leveraged long position in the BTC/ETH market. This means that your position is worth $1500 out of which $100 is yours and the remaining is borrowed.
Now imagine that BTC drops by 10%. What happens? Your position is now worth $1350. That's a bummer, right?
However, imagine that your position continues to lose money. This means that the borrowed funds will definitely be affected but the lender surely doesn't want to lose money on your account. Because of this, your position will most likely be liquidated to safeguard the capital of the lender. Thus, you'll lose your $100 investment.
Keep in mind that a liquidation fee is usually added to forced liquidation. It differs between platforms platform. However, it encourages traders to close their positions before they get closed automatically. Though a lot of trading platforms allow users to evaluate the liquidation price of a position before it is entered.
Additionally, note that liquidation might also be utilized when talking about bankruptcy. When a person or a company has to convert its assets into cash, it's referred to as liquidation. In this case, cash is perceived as a "liquid" form of an asset.