BTC
Capital liquidation
Investing.com - With every sharp decline in the cryptocurrency market or a specific currency, we hear about million-dollar liquidations and huge losses incurred by traders. In this article, we provide you with an explanation of liquidations and how to avoid them.
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What happened yesterday.. Why did the markets collapse and $900 million was liquidated?
Yesterday, after the US Federal Reserve decided to cut interest rates by 25 basis points and issued its future expectations to cut only 50 basis points in 2025 instead of 100 basis points in the previous expectations, with raising future targets for interest rates in the following years. This prompted the markets to price this monetary tightening from the Federal Reserve and negatively affected the stock market, digital currencies and gold, and led to the liquidation of nearly 900 million in the digital currency market.
What is liquidation and in which markets does it occur?
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Liquidation mainly occurs for futures traders. Liquidation is the process of forcing the closing of trading positions, and it is not specific to cryptocurrencies only, but it exists in any futures market, whether for stocks, currencies or crypto.
Futures are derivatives where traders speculate on the direction of a currency. They do not own it, but they speculate on its future rise or fall. If their bet is successful, they make money, but if it is not successful and the currency moves in the opposite direction, they lose.
So let’s take an example if Bitcoin is trading at $100k and you bet it will go to $110k and you translate that bet into a long position, but Bitcoin drops to $90k. In this case you will lose your money but you will not be completely liquidated.
When does liquidation occur?
Liquidation occurs in only two cases in the cryptocurrency futures market. The first case is if the currency price falls to zero, in which case you will lose all the money you put into the deal.
The second and most common case is when you use leverage. Leverage is an economic risk that traders take to maximize their profits if their trades in the digital currency market win. The trader enters a trade with $100 and uses a 10x leverage, meaning that he maximizes his profits in the event of a win tenfold to get the same profits he would have gotten if he had traded with $1000. However, if he loses, the situation is reversed and instead of losing $10 if he trades without leverage, he loses $100 and turns to zero.
Financial exchanges use a liquidation system to protect their profits. They are your lender if you use leverage to enhance your purchasing power, but they cover this loan immediately if your trade turns into a loss.
Note that the more you borrow from the platform, the higher your liquidation percentage will be. If you borrow only $100 from the platform, i.e. using 2x leverage, then the trade will not be liquidated unless the price of Bitcoin drops by 50%. If you borrow $200 from the platform, this means doubling your capital, and therefore the trade will be liquidated when it drops by approximately 33%.
Some people lose all their money, not just the value of the deal.
In some cases, the liquidation does not only occur for the deal capital, but for the trader's account and his entire capital. If the trader uses leverage with a cross account, meaning that he supports his deal in futures contracts using all his capital, which makes the platform cover his loss from his account, and if the capital is modest and the trader uses high leverage, this may lead to the loss of the trader's entire capital. Therefore, some people use the isolated feature, which makes the liquidation limited to the deal only and futures contract positions.
It is always advisable to use stop loss tools when trading in the futures market to avoid complete liquidation.
Leverage in Crypto
Cryptocurrency platforms and exchanges promote exceptional leverage with leverages up to 100x. In a market characterized by violent volatility, the risks are always high.
If you have $100 and use 100x leverage, your purchasing power becomes $10,000, but if you fall by even 1%, it will mean liquidating your capital completely.
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