How liquidations happen
Every leveraged position has a liquidation price — the level at which the margin posted is no longer enough to cover the potential loss. When price crosses that level, the exchange takes over: the position is closed at market, the margin is forfeited, and any surplus (rare) or shortfall (expensive, covered by the exchange’s insurance fund) is settled.
A concrete example: you open a $10,000 long BTC position with $1,000 of margin (10x leverage) at $60,000. If the maintenance margin is 5%, the position will be liquidated at roughly $54,600 — a 9% move against you. Your $1,000 is gone; the $600 difference between liquidation price and market is absorbed by the insurance fund or passed on to opposing traders (an ADL, or auto-deleveraging).
DeFi liquidations work the same conceptually but execute via public keeper bots: any address can call the liquidation function and claim a bonus (typically 5-10% of the collateral) for doing the exchange’s job.
Cascade dynamics
When many positions share similar liquidation levels — common during strongly-trended rallies or crashes where traders pile in with similar leverage — a move to that level triggers forced selling, which extends the move, which triggers the next cluster of liquidations. The March 2020 crash, the May 2021 leverage wipeout, and the October 2024 flash crash all followed this pattern. Exchange data feeds show liquidation heatmaps traders watch specifically to anticipate where the next cascade is likely.
Risks and considerations
Liquidation losses are 100% of the collateral by definition — unlike a losing trade you voluntarily close, there’s no partial recovery. The practical defenses: size positions so liquidation price is far from realistic price action, use isolated margin so one bad trade can’t drain the whole account, and add collateral proactively if the price approaches the liquidation level (most exchanges let you top up margin in real time). Professional traders treat the liquidation price as a hard boundary they never want price to approach, not a stop-loss.