The main point
Liquidation occurs when the margin balance falls below the maintenance margin. The liquidation price is the point when a trader's position begins to enter liquidation.
The bankruptcy price is the point when the trader's loss is equal to the value of the collateral deposited or the initial margin.
In a liquidation order, the liquidation price corresponds to the stop price, while the bankruptcy price is the limit price when the order will be executed.
Traders often face liquidation in cryptocurrency futures. Beginners unfamiliar with cryptocurrency derivatives may find liquidation execution for their open positions confusing.
On Binance Futures, liquidation orders are executed taking into account the liquidation price and bankruptcy price. These are two important price points that traders need to know when trading perpetual contracts. This article discusses the role of liquidation and bankruptcy prices in the execution of liquidation orders.
Liquidation Basics
Liquidation occurs when the margin balance falls below the maintenance margin. The margin balance is the sum of the wallet balance and unrealized PnL, while the maintenance margin is the minimum amount of margin that traders must maintain to keep their futures positions open.
On Binance Futures, liquidations occur at the Mark Price, which is the estimated true value of a contract. Mark prices consider the fair value of assets to prevent unnecessary liquidation during volatile markets. On the other hand, Last Price refers to the most recent trading price of a futures contract on Binance.
Liquidation Price vs. Liquidation Price The Price of Bankruptcy
The liquidation price is the price when the position will start to enter liquidation. There are several factors that can influence this threshold, including the leverage used, the maintenance margin level, the current price of the cryptocurrency, and the remaining balance of the trader's account.
The bankruptcy price is the price when the trader's loss becomes equal to the value of the collateral deposited or the initial margin. At this point, the user's liquidated margin balance will be equal to zero.
How are liquidation orders executed?
We will now explain how liquidation orders are executed in the context of these two prices. In practice, liquidation orders work similarly to limit orders placed on bankruptcy prices. But to get a better picture, let's look at the execution of a liquidation order as a two-step stop-limit order.
In a stop-limit order, you select the stop price (either the Last price or the Mark price) and the limit price when your order will be executed. When your position reaches the stop price, a limit order will be triggered and executed at the limit price.
Let's consider a liquidation order as a stop-limit order with the trigger type price as the Mark price. The stop-limit order is triggered when your position reaches the Mark price. In a liquidation order, the liquidation price is the stop price, while the bankruptcy price is the limit price when the order will be executed.
So, when the contract price exceeds the liquidation price, the liquidation process begins. The bankruptcy price is the limit price used when the user's margin balance will be liquidated.
Insurance fund
Binance Futures uses an Insurance Fund to protect bankrupt traders from losses and guarantee that successful traders' profits are paid out in full.
As explained above, traders are vulnerable to liquidation when their collateral is less than their maintenance margin. When these traders are unable to sell their positions or have a negative account balance after all positions have been liquidated, they are declared bankrupt. In this situation, Binance took control of the remainder of their position.
For example, a trader's position is liquidated at a price higher than the bankruptcy price (that is, the loss does not exceed the initial margin). In this case, the remaining funds obtained will go to the insurance fund.
However, if the liquidation price is lower than the bankruptcy price, the trader's losses will exceed his initial margin. In this case, the Insurance Fund will cover the deficit.
Conclusion
You should be familiar with the concept of liquidation and how to prevent it before trading cryptocurrency derivatives. Liquidation occurs when an individual cannot meet the margin required for their leveraged position in the market.
To avoid liquidation, you are advised to pay close attention to margin ratios, use leverage responsibly, avoid accumulating more contracts in a losing position, and utilize trading tools such as stop-loss orders.
Read the following articles to learn more about liquidations in crypto trading and how to avoid them:
(Blog) Three Misconceptions about Liquidation on Binance Futures
(FAQ) How to Reduce Your Chances of Being Liquidated
(FAQ) How Liquidation Works in Futures Trading
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