Liquidation is the crypto market’s version of hitting the panic button on your trade. Exchanges use this as a safety net to make sure they don’t lose money when a trader makes a bad bet.
In the world of crypto, many people use leverage, which is essentially borrowing extra cash from an exchange, to buy more than they can afford. However, leverage is a double-edged sword. Say you have $100 but want to trade with $1,000 in Bitcoin, the exchange lends you the extra $900. The result is 10x leverage. Now, it’s great if the price goes up, but it’s incredibly dangerous if the price drops. In case prices drop, the exchange won’t just sit by and watch its borrowed money vanish. Instead, they will liquidate you and take your pledged collateral to cover the debt.
Here’s how this works. In a positive scenario, Bitcoin goes up 10%. Your $1,000 becomes $1,100. You sell, pay back the $900, and keep the remaining $200. You just doubled your money! But on the flipside, Bitcoin drops by 10%. Your $1,000 position is now only worth $900. Since that $900 belongs to the exchange, your original $100 cushion is gone. To protect themselves, the exchange triggers a liquidation. They instantly sell your Bitcoin to get their $900 back. You are left with $0.
In crypto, prices can swing 10% in minutes. If you’re overleveraged, a tiny dip can result in your entire investment being wiped out instantly.
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