People confuse liquidity and liquidations. They look at Coinglass and think that the yellow stripes of liquidations are the decisive factor in where the price will go. Let's clarify this.
What are liquidations? 🔄
Liquidation in the context of the cryptocurrency market is the process by which an exchange 💻 automatically closes a trader's position due to insufficient funds to cover losses. This occurs when the balance in the margin account 📉 falls below a certain level (margin requirement).
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Liquidations as an element of liquidity 💧
Liquidations can temporarily increase market activity, but they cannot be considered a full part of liquidity. 🚀
🔥 How they affect the market:
1. Increase in trading volumes 📈: During liquidations, the number of transactions rises, creating the illusion of high liquidity.
2. Increase in volatility ⚡: Closing large positions can trigger a chain reaction, amplifying price fluctuations.
3. Domino effect 🧩: In low-liquidity markets, liquidations of large positions can trigger cascading sell-offs.
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What is the share of liquidations in total liquidity? 🧐
During sharp market movements, liquidations can account for up to 10–20% of trading volumes in futures markets.
Such factors as:
Leverage 🔗: The higher the leverage, the greater the risk of liquidations.
Market conditions 🌪️: During a flat market, liquidations are fewer, while during strong movements, their share increases.
Total liquidity volume 💹: In less active markets, their impact is significantly higher.
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Conclusion ✍️
Liquidations play a dual role in the cryptocurrency ecosystem:
On one hand, they temporarily increase market activity 🚦.
On the other hand, excessive liquidations can increase volatility, which deters market participants 😟.
⚠️ It is important for exchanges to implement risk management mechanisms, such as reducing maximum leverage and improving margin requirements, to mitigate the negative impact of liquidations on the market.
💡 Liquidations are not only a risk but also an indicator of market health, helping to understand the dynamics of volatility and liquidity.