Cascading Liquidation Spiral
A cascading liquidation spiral occurs in leveraged financial markets when a sharp decline in asset price triggers automatic liquidations of collateralized positions. As these positions are closed to repay debts, the resulting sell orders drive the price even lower.
This lower price then triggers further liquidations for other traders who are now under-collateralized. This feedback loop continues, often accelerating rapidly as liquidity is exhausted and order books thin out.
In crypto markets, this is frequently exacerbated by high leverage and automated margin engines that lack circuit breakers. The process effectively wipes out over-leveraged market participants in a short timeframe.
It is a core example of systemic risk where individual rational actions lead to a collective market collapse. The spiral ends only when the asset price stabilizes or the market runs out of forced sellers.
Understanding this phenomenon is essential for risk management in decentralized finance.