Forced Liquidation Spiral

A forced liquidation spiral is a systemic event where the liquidation of large positions causes further price drops, triggering more liquidations in a feedback loop. This occurs when market liquidity is thin and the sudden sell-off of collateral overwhelms the available buy-side demand.

These spirals can lead to flash crashes and significant losses for both traders and the protocol. They are a primary concern for risk managers and protocol designers.

Preventing such spirals requires deep liquidity and efficient liquidation mechanisms that do not flood the market. It is a major example of systemic risk in digital asset markets.