Automated liquidations are executed by a pre-programmed algorithm designed to close a trader’s leveraged position when the collateral value drops below the maintenance margin requirement. This process is triggered automatically to prevent further losses from exceeding the initial margin deposit. The algorithm typically sells the underlying asset or closes the derivative contract at market price to restore the account balance to zero or a positive value.
Margin
The system continuously monitors the margin ratio of all leveraged positions against predefined thresholds. When the margin level falls below the required maintenance level, the automated liquidation process initiates immediately. This mechanism ensures that the exchange or protocol maintains solvency by preventing individual account losses from becoming bad debt that must be covered by an insurance fund.
Consequence
For traders, automated liquidations result in the complete or partial loss of their collateral and a forced exit from the position. The rapid execution of these liquidations can contribute to market volatility, especially during sharp price movements, creating cascading effects as multiple positions are closed simultaneously. Understanding the specific margin requirements and liquidation thresholds is essential for managing risk in derivatives trading.
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