Highlights

  • Liquidation occurs when the margin balance falls below the maintenance margin. The liquidation price is the point at which the trader's position begins to enter liquidation.

  • The bankruptcy price is the point at which the trader's losses equal the value of the deposited collateral or the initial margin.

  • In a liquidation order, the liquidation price corresponds to the stop price, while the bankruptcy price is the limit price at which the order will be executed.

When trading cryptocurrency futures, traders often face liquidation. Beginners unfamiliar with cryptocurrency derivatives may find executing a liquidation of their open positions confusing.

On Binance Futures, a liquidation order is executed taking into account the liquidation price and the bankruptcy price. These are the two important price points that traders should always check when trading perpetual contracts. This article analyzes the role of liquidation and bankruptcy prices in the execution of a liquidation order.

The basics of liquidation

Liquidation occurs when the margin balance falls below the maintenance margin. Margin balance is the sum of wallet balance and unrealized PnL, while maintenance margin is the minimum amount of margin that traders must maintain to keep their futures position open.

On Binance Futures, settlement occurs at the Mark Price, which is the estimated true value of a contract. Mark Price considers the fair value of an asset to avoid unnecessary liquidations during a volatile market. On the other hand, the Last Price refers to the price of the most recent trade of a futures contract on Binance.

Liquidation price vs. bankruptcy price

The liquidation price is the price at which a position will begin to enter liquidation. Several factors can influence this threshold, including the leverage used, the maintenance margin rate, the current price of the cryptocurrency, and the trader's remaining account balance.

The bankruptcy price is the price at which the trader's losses become equivalent to the value of the deposited collateral or the initial margin. It is the point at which the user's settled margin balance will be equal to zero.

How is a liquidation order executed?

We will now explain how a liquidation order is executed in the context of these two prices. In practice, a liquidation order behaves similarly to a Limit order entered at the bankruptcy price. But for clarity, let's look at the execution of liquidation orders as a two-step stop-limit order.

In a stop-limit order, you choose a stop price (either the Last Price or the Mark Price) and a limit price at which your order will be executed. When your position reaches the stop price, the Limit order will be activated and executed at the limit price.

Let's consider a liquidation order to be a stop-limit order with the Mark Price as the trigger price. A stop-limit order is activated when your position reaches the Mark Price. In a liquidation order, the liquidation price is the stop price, while the bust price is the limit price at which the order will be executed.

Then, when the contract price exceeds the settlement price, the settlement process begins. The bankruptcy price is the limit price at which the user's margin balance will be liquidated.

insurance fund

Binance Futures uses an Insurance Fund to protect failed traders from losses and ensure that successful traders' profits are paid in full.

As we have seen, traders are subject to liquidation when their collateral is less than their maintenance margin. When traders cannot sell their positions or have a negative account balance after liquidating all their positions, they declare bankruptcy. In this situation, Binance takes control of its remaining positions.

Suppose a trader's position is liquidated at a price higher than the bankruptcy price (meaning his losses do not exceed his initial margin). In that case, the remaining funds obtained will go to the insurance fund.

However, if the liquidation price is lower than the bankruptcy price, the trader's losses would have exceeded his initial margin. In this case, the insurance fund will cover the shortfall.

In conclusion

It is crucial to familiarize yourself with the concept of liquidation and how to prevent it before engaging in cryptocurrency derivatives trading. Liquidation occurs when a person is unable to meet the margin required for their leveraged position in the market.

To avoid liquidation, it is advisable to closely monitor your margin ratio, use leverage responsibly, avoid accumulating more contracts in a losing position, and use trading tools such as stop-loss orders.

Read the following articles to learn more about liquidation in cryptocurrency trading and how to avoid it:

  • Three Misconceptions About Liquidations on Binance Futures

  • How to reduce the likelihood of a liquidation

  • How settlement works in futures trading

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