You might have heard some of your friends who trade crypto say, I got my position liquidated on the exchange. I had a leverage of 10X, and unfortunately, the market turned against me, and I lost all the money. But you wondered what leverage was and what getting liquidated was, and then nodded your head. If this sounds like you, then this article could be helpful for you. Here we will be discussing all those jargon that threw you off. So, the next time your friends talk about their crypto positions, you’ll get along rather than manage the situation.
What is forced liquidation?
Forced liquidation happens when crypto assets are converted into cash or equivalent stablecoins after a trader’s collateral falls below a certain threshold, which the exchange decides. Yes, I know you did not understand the definition. Let’s break it down.
When you open a position on an exchange, you may not have much money to invest in crypto trading. Let’s say you have $1000 that you want to invest in, but the capital may seem too little. To increase the amount of money you put in, exchanges offer a loan. On an exchange, you have the option to multiply your initial investment by 2X, 3X up to sometimes even 100X, depending on the exchange and your relationship with the exchange. This feature is called leverage, and it helps the traders overcome the initial barrier of having a lump amount of money.
How does forced liquidation occur?
With the $1000 in hand, you open a long position, which is 10X leveraged. Now it means that we have a position of $10,000 on Bitcoin. Let’s say Bitcoin, which was at $60,000, dropped by 10% to $54,000, going against your bet. When this happens, your position loses 10% of $10,000, which is $1,000.
Since the exchange does not want to lose more money on the trader’s behalf, it will automatically close the position at the liquidation price of $54,000, claiming the $1,000. Your loss will be $1,000. Now that we have looked at an example, let’s take a look at a real incident that took place not long ago.
A high-risk trader who goes by the pseudonym James Wynn lost $100 million when the market went against him. Wynn leveraged his position by 40X on the Hyperliquid exchange, betting long on Bitcoin. Unlike other traders, who pull out of the position when they start losing, Wynn was collateralizing more funds. A tweet stated, “In this case, he went from $0 on this account pnl to $88m to negative 14m (after continually selling other spot assets in his accounts to add collateral.)”
Hard reality
Did I tell you that the markets moved against Wynn the trader? Well, I meant to say that it was a natural movement. However, a crypto investigator who goes by the pseudonym, Stellar Rippler, made some moving remarks about this loss on X. According to Rippler, “James Wynn’s $100M Liquidation …. EXPOSED the BIGGEST SCAM Of All.” The investigator stated that exchanges orchestrate this kind of market movement to liquidate positions.
In fact, Rippler mentioned that exchanges have a data monopoly; they see your open positions, your liquidation price, your leverage, your stop losses, your emotions through trading patterns, and they know when you’re most vulnerable, and they use it against you.
To carry out these unethical practices, exchanges have a market-making desk that runs in the background, and when the trader loses, it’s their win. On top of that, the exchanges have enough liquidity or volume to move the market prices, and making use of this volume to their advantage, they make sudden falls and quick recoveries, to dismantle the market and liquidate positions. The investigator mentioned that “Those [sudden falls and recoveries] aren’t random. They’re engineered.”
Exchanges love leverage as more leverage means more guaranteed fees and potential asset grab. And in 2023 alone, $10.3 million in long and short liquidations were recorded. So the bottom line according Rippler is that prices are manipulated, your data is used against you, and your trades are food.
So, how do you prevent this from happening?
Invest only what you are willing to lose:
When investing in crypto, you must only invest what you can afford to lose. After all, you are investing in a volatile market, where the prices could move by a large margin.
Keep the leverage to a minimum:
If you are using leverage on the platform, start by using 2X to minimize the losses. Make sure that you don’t leverage events like the Consumer Price Index (CPI), FED meetings, major crypto events, or other world events that could whip-saw volatility.
Don’t revenge trade:
After losing a leveraged position, the urge to win back will reach its threshold. Do not give in to it and increase your leverage, trying to regain the losses. Make sure you take calculated risks and do not make decisions when you are high on emotions.
Don’t go all in
When you invest, do not invest your whole capital in one trade. Just make sure that you risk 1-5%. This makes sure that the risk factor is spread across your portfolio.
Pseudo trade:
Many platforms offer virtual funds where you can play around and get to know how it works. So, begin by pseudo trading, and learn the tricks of the trade before you enter the market.
