Understanding Liquidation Processes on LBank
The cryptocurrency market is known for its high volatility, presenting both opportunities and risks for traders. One significant risk that traders face, especially those engaged in margin trading with leveraged positions, is the possibility of liquidation. In this article, we will look into the concept of liquidation, why it occurs, and the specific liquidation processes employed by LBank, a prominent cryptocurrency exchange.
Understanding Margin Trading
Margin trading involves borrowing funds from a cryptocurrency exchange to increase the size of a trading position. Exchanges like LBank, provide platforms for margin trading, allowing traders to use borrowed funds to enhance their earning potential. However, the borrowed funds come with the risk of losing the invested capital, and inexperienced traders can find themselves facing rapid and substantial losses.
Leverage amplifies both potential gains and losses. It allows traders to control larger positions with a smaller amount of capital. For example, using 5x leverage on an initial margin of $100 enables the trader to take out a $400 loan, increasing the overall trading position to $500. While this leverage can magnify profits if the market moves favorably, it equally heightens the risk of significant losses if the market moves against the position.
What is Liquidation?
Liquidation is a crucial aspect of trading with leverage, and it occurs when an investor takes a leveraged position that results in an inability to meet margin requirements. In simple terms, if the trader’s collateral (Initial Collateral + Realized PnL + Unrealized PnL) falls below the maintenance margin, the exchange automatically closes the trader’s position. This leads to potential partial or total loss of the trader’s initial margin, depending on the severity of the price drop.
Liquidation is a risk inherent in both margin and futures trading, and it can lead to the loss of the entire collateral if the market makes a substantial move against the leveraged position.
LBank’s Approach to Liquidation
LBank employs a system that utilizes the Mark Price to minimize unnecessary liquidations and counteract market manipulation. The trigger for liquidation is when the Collateral falls below the Maintenance Margin, leading to the activation of “Smart Liquidation” protocols. LBank aims to avoid a complete clear of the user’s position and charges a liquidation fee (0.3% on BTC/USDT perpetual contract; 0.5% on all other perpetual contracts) on the amount liquidated.
Liquidation Procedures on LBank
- Cancellation of Open Orders: On liquidation, all open orders are immediately canceled. This is a crucial step to prevent additional exposure to market risks.
- Immediate or Cancel Orders: All liquidation orders are Immediate or Cancel orders, meaning they will fill as much as possible and cancel the rest. This ensures swift action during the liquidation process.
- Smart Liquidation Attempt: The system first cancels all open orders, then attempts to reduce the trader’s margin usage with a single large Immediate or Cancel order. If the trader is still margin deficient after the order and liquidation fee, the position is closed at the bankruptcy price.
- Insurance Fund and Counterparty Liquidation: If the position cannot be fully closed, the insurance fund and/or counterparty liquidation mechanisms come into play. The insurance fund accumulates USDT reserves based on liquidations above the bankruptcy price.
Understanding Liquidation Price
Liquidation occurs when the Mark Price hits the liquidation price of a position. Traders are advised to closely monitor both the Mark Price and the liquidation price to avoid unexpected liquidations.
In hedge mode, long and short positions of the same contract share the same liquidation price in cross margin mode. In isolated mode, positions may have different liquidation prices based on the allocated margin.
Managing Risk in Leveraged Trading
- Setting Stop Loss: Traders can mitigate the risk of liquidation by setting stop-loss orders, instructing the exchange to sell an asset when it reaches a predetermined price.
- Proper Leverage and Position Sizing: Higher leverage increases the risk of liquidation. Traders should carefully choose leverage and manage position size to prevent excessive exposure.
- Risk Management Strategies: Understanding risk management is essential. Traders should deploy mechanisms to survive unexpected market moves, considering the potential losses associated with leverage.
Wrapping Up
Leveraged trading in the cryptocurrency market offers opportunities for substantial profits, but it comes with inherent risks, including the possibility of liquidation. LBank’s approach to liquidation emphasizes smart protocols, immediate actions, and the use of an insurance fund.
Traders, especially those new to leveraged trading, must prioritize risk management, set stop-loss orders, and carefully choose leverage to navigate this high-risk landscape successfully. Understanding liquidation processes is a fundamental aspect of achieving long-term success in the dynamic world of cryptocurrency trading.
Disclaimer: Derivatives are often volatile, and this can be a risky investment. The information provided in this article is solely for educational purposes and shouldn’t be regarded as financial advice.
