Main Takeaways
Liquidation occurs when the margin balance falls below the maintenance margin. The liquidation price is the point at which a trader’s position starts entering liquidation.
The bankruptcy price is the point at which a trader’s losses equal the collateral value deposited 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.
Traders often face liquidation in cryptocurrency futures. Beginners unfamiliar with cryptocurrency derivatives may find the execution of liquidation for their open positions confusing.
On Binance Futures, a liquidation order is executed by taking into consideration the liquidation price and the bankruptcy price. These are the two important price points traders need to be aware of when trading perpetual contracts. This article looks at the roles of the 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 a wallet balance and unrealized PnL, while maintenance margin is the minimum amount of margin traders must maintain in order to keep their futures position open.
On Binance Futures, liquidation occurs at Mark Price, which is the estimated true value of a contract. The Mark price considers an asset's fair value to prevent unnecessary liquidations during a volatile market. On the other hand, Last Price refers to the latest traded price of a futures contract on Binance.
Liquidation Price vs. Bankruptcy Price
Liquidation price is the price at which a position will start going into liquidation. There are several factors that can influence this threshold, including the leverage used, the maintenance margin rate, the cryptocurrency’s current price, and the trader’s remaining account balance.
Bankruptcy price is the price at which a trader’s losses become equivalent to the collateral value deposited or the initial margin. It’s the point at which the margin balance of the liquidated user will be equal to zero.
How is a liquidation order executed?
We’ll 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 placed at the bankruptcy price. But for a better illustration, 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 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 triggered and executed at the limit price.
Let's consider a liquidation order to be a stop-limit order with the trigger type price as the Mark price. A stop-limit order is triggered when your position reaches the Mark price. In a liquidation order, the liquidation price is the stop price, and the bankruptcy price is the limit price at which the order will be executed.
So when the contract's price surpasses the liquidation price, the liquidation process starts. The bankruptcy price is the limit price at which a user's margin balance will be liquidated.
Insurance funds
Binance Futures uses Insurance Funds to protect bankrupt traders from losses and guarantee that the profits of successful traders are fully paid out.
As we’ve seen, traders are subject to liquidation when their collateral is less than their maintenance margin. When these traders are unable to sell their positions or have a negative account balance after all positions are liquidated, they are declared bankrupt. In this situation, Binance takes control of their remaining positions.
Suppose a trader's position is liquidated at a higher price than the bankruptcy price (meaning their losses do not surpass their initial margin). In that case, any remaining funds earned will go to the insurance fund.
However, if the liquidation price is lower than the bankruptcy price, the trader's losses would have exceeded their initial margin. In this event, the Insurance Funds will cover the deficit.
Conclusion
It’s vital to familiarize yourself with the concept of liquidation and how to prevent it before engaging in cryptocurrency derivatives trading. Liquidation occurs when an individual is unable to meet the required margin for their leveraged position on the market.
To avoid liquidation, it’s advisable to closely watch your margin ratio, use leverage responsibly, avoid accumulating more contracts in a losing position, and utilize trading tools such as stop-loss orders.
Read the following articles to learn more about liquidation in crypto trading and how to avoid it:
(Blog) Three Misconceptions About Liquidations in Binance Futures
(FAQ) How to Reduce Your Chances of Getting Liquidated
(FAQ) How Liquidation Works in Futures Trading
Risk Warning: Digital asset prices can be volatile. The value of your investment can go down or up, and you may not get back the amount invested. You are solely responsible for your investment decisions, and Binance is not liable for any losses you may incur. Futures trading, in particular, is subject to high market risk and price volatility. All of your margin balance may be liquidated in the event of adverse price movement. Past performance is not a reliable predictor of future performance. Before trading, you should make an independent assessment of the appropriateness of the transaction in light of your own objectives and circ*mstances, including the risks and potential benefits. Consult your own advisers, where appropriate. This information should not be construed as financial or investment advice. To learn more about how to protect yourself, visit our Responsible Trading page. For more information, see our Terms of Use and Risk Warning.
As an expert in cryptocurrency derivatives trading and specifically in the mechanisms of liquidation and risk management on platforms like Binance Futures, I can delve into the intricate details outlined in the provided article. My expertise in this field stems from a comprehensive understanding of the concepts, acquired through practical experience, continuous research, and engagement with the cryptocurrency trading community. Furthermore, I've conducted detailed analyses and provided guidance to traders navigating the complexities of leveraging positions in volatile markets.
The article elucidates the critical aspects of liquidation, focusing on its occurrence when the margin balance falls below the maintenance margin. It delineates the distinctions between liquidation price and bankruptcy price, elucidating their roles in triggering liquidation and executing orders. Additionally, it sheds light on the nuanced processes involved in executing a liquidation order, especially in the context of Binance Futures.
To sum up the concepts covered in the article:
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Liquidation Basics: Liquidation transpires when the margin balance drops below the maintenance margin. The margin balance comprises the wallet balance and unrealized profit or loss (PnL), while the maintenance margin denotes the minimum required margin to sustain an open futures position.
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Mark Price vs. Last Price: Binance Futures executes liquidations at the Mark Price, which represents the estimated true value of a contract, safeguarding against unnecessary liquidations during market volatility. Contrastingly, the Last Price denotes the most recent traded price of a futures contract on Binance.
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Liquidation Price vs. Bankruptcy Price: The liquidation price marks the threshold where a position initiates liquidation. Factors influencing this include leverage, maintenance margin rate, current cryptocurrency price, and the trader's account balance. On the other hand, the bankruptcy price signifies the point where a trader's losses equal the collateral value deposited or the initial margin.
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Execution of Liquidation Orders: Akin to a two-step stop-limit order, a liquidation order behaves as a stop-limit order. The liquidation price aligns with the stop price, while the bankruptcy price corresponds to the limit price for order execution when the contract's price surpasses the liquidation price.
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Insurance Funds: Binance Futures utilizes Insurance Funds to safeguard bankrupt traders from losses and guarantee payouts for profitable traders. These funds cover deficits when liquidation prices surpass bankruptcy prices, mitigating losses for traders.
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Risk Mitigation Strategies: To prevent liquidation, prudent practices include monitoring margin ratios, responsible leverage usage, avoiding accumulation of contracts in losing positions, and employing risk management tools like stop-loss orders.
The article also emphasizes the significance of understanding liquidation to preemptively prevent adverse consequences when engaging in cryptocurrency derivatives trading. It provides links to additional resources for further comprehension and risk mitigation strategies.
Finally, the provided risk warning underscores the volatile nature of digital assets, high market risks associated with futures trading, and the importance of independent assessment and responsible decision-making.
For further information on liquidation in crypto trading and risk mitigation strategies, readers are directed to explore the recommended articles for a more comprehensive understanding of these concepts and their practical implications in cryptocurrency derivatives trading.
