(liquidation occurs in situations of marginal loss, and traders are not able to keep the trade)
Cryptocurrencies are known for their volatile nature. With this volatility, the investors find a most lucrative investment option. This also shows the prime target of cryptocurrencies is liquidation.
Liquidation occurs when investors can not meet the margin standard for their leveraged position. In that condition, traders increase their funds by borrowing from a third party. These investors also try to maximize their gains.
With this investment market, the risks and profits are both multiplied. It’s a high-risk market where investors only make some additional gains.in a leveraged position, a trader uses the underlying asset as collateral to borrow the funds or loans.
For instance, if traders increase their funds by borrowing from a third party in the hope their gain will increase, this strategy can also go wrong, and traders can experience enormous losses.
In this article, we will discuss what liquidation is and how it can affect your investment.
What is crypto liquidation?
In simple words, we can understand liquidation as selling off a crypto asset in exchange for cash to minimize the loss in the situation of the market cash. Liquidation occurs when traders are not able to meet the set leveraged positions and out the fund to keep the trade.
However, in the crypto world, this term refers to when a trader or investor is forced to close his position on the trade due to some marginal loss. In other words, liquidation can also refer to the ability to convert a digital asset into cash. In crypt space, a trader’s position is often closed as the price drops of the cryptos. Since the margin is not enough to cover the losses, this is known as liquidation.
How does crypto liquidation happen?
Make an assumption that the leverage ratio is 10X, and you buy $20,000 digital assets for $1000.If the price goes higher and increases approx 5% you will gain approx $500 profit which can be calculated approx 50 % return. If the price falls and drops approx 5 % you will lose $500 which is also 50%. However, if the loss occurs at 10 % which is $1000 the trade will automatically close on the exchange.
How can liquidation impact the market?
The investor can benefit from the liquidation when the crypto market is high and profitable. However, when the market faces a downfall, liquidation also affects the market, and traders face a loss like the traditional market cryptocurrency market is also not always equal. Bull and bear both; the market doesn’t last forever.
How to avoid crypto liquidation?
There is no denying that liquidation is a common concern in cryptocurrency. Liquidation can not be eliminated. The risk is equivalent to the leverage ratio; the higher the leverage ratio the chance to be higher. However, this risk can minimize to some extent by using some strategies. The volatility of the crypt market can benefit investors differently. With the right time and method, one can conquer the market.
When it comes to marginal trading, managing the risk is one of the most crucial factors – Stop loss is one strategy that can reduce the liquidation risks. Stop loss is set up a specific price to close the trade. With marginal trading, you can increase your potential at the same time; you should be prepared for the loss.
You should always set your stool at the correct position, although there is no fixed strategy to place the stop loss. A suggestion to set the stop loss between 2-5 % is always preferable. However, you can also set the stop loss according to risk tolerance and trading size.
Setting an insurance pool
Crypto exchange platforms can also set up a reserved pool to minimize the risks. This can cover the contract loss. In this situation, if the liquidation price is higher than the initial margin. The insurance pool will pay for the loss. The Crypto exchange platform reserved some charge in the insurance pool for each leverage position to reduce the loss.
The article should not be sued to make any investment decision. Investing is your personal choice. Cryptocurrencies are highly volatile, so liquidations are a common factor that can not be ignored. Many platforms lowered traders’ limits with the risks associated with margin trading and liquidation. Binance and FTX are the platforms that can limit liquidating risks to 100 to 20 X.before you make any investment decision. You should fully understand the risk associated with crypto investment.