In the volatile world of digital asset trading, risk management mechanisms are crucial for maintaining market stability and protecting investors. One such mechanism is early liquidation, a specific form of forced liquidation designed to mitigate adverse effects caused by extreme market fluctuations.
This process helps prevent cascading liquidations and over-loss situations, where positions cannot be closed at available market prices. To fully grasp how early liquidation works, it’s essential to first understand related concepts like Auto-Deleveraging and standard forced liquidation protocols.
What Is Auto-Deleveraging?
Auto-Deleveraging (ADL) is a protective mechanism activated during extreme market conditions or unforeseen events. It triggers when a platform’s risk reserve fund is insufficient or depletes rapidly—typically defined as a 30% straight-line drop from its peak within eight hours. Note that platforms may adjust these parameters based on market behavior.
Once ADL is initiated, the platform no longer relies on placing orders in the market and waiting for matching trades. Instead, it directly targets the accounts positioned highest in the counterparty queue. Their positions are closed at the current mark price, converting any realized profits into available account balance.
This approach prevents loss allocation across users. Affected users receive notifications via SMS and email with details about the reduced positions and prices. They can also review these actions in their order history under the "Auto-Deleveraging" bill type.
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How Forced Liquidation Works
Forced liquidation, commonly known as "liquidation," occurs when a position moves against the trader and can no longer be sustained by the available margin. The exact conditions vary based on the margin mode.
In cross-margin mode, liquidation is triggered when the maintenance margin ratio falls to or below the tier’s required maintenance margin rate plus the liquidation fee rate. In isolated-margin mode, the same condition applies but is specific to that particular position.
Conditions for Partial and Full Liquidation
When a user’s position is at tier 3 or higher, and the maintenance margin ratio drops below the required level (but remains above the lowest tier’s requirement), the system does not immediately liquidate the entire position. Instead, it calculates the number of contracts needed to reduce the position by two tiers. If the margin ratio becomes adequate after this reduction, the process stops. If not, the system continues the partial liquidation cycle.
If the position is at tier 2 or lower and the margin ratio falls below the required level, or if it’s at tier 3+ but below the lowest tier’s requirement, the system triggers full liquidation. The entire position is handed over to the liquidation engine at the bankruptcy price—where the maintenance margin ratio reaches zero.
Upon forced liquidation, the engine takes over the position. The maximum loss incurred is equal to the initial margin of the position, ensuring that losses do not exceed the committed collateral.
The Role of the Risk Reserve Fund
The risk reserve fund acts as a safety net for platforms to cover losses from over-liquidated positions. It is funded primarily from two sources: allocations from the platform itself and remaining margins from liquidated orders.
These funds are segregated by business type—such as leverage trading, futures, perpetual swaps, and options. Within each business line, risk reserves are further separated by contract type and currency.
Every day at 16:00 HKT, the platform settles all gains and losses from liquidations and reductions that occurred since the same time the previous day. These are then transferred into or out of the risk reserve fund, recorded as over-loss or liquidation injections.
How to View the Risk Reserve
To check the status of the risk reserve on most platforms, navigate to the trading section and select “Market Information” or an equivalent option. From there, access the “Risk Reserve” menu to view details for different contract types and currencies.
Frequently Asked Questions
What is the main purpose of early liquidation?
Early liquidation helps prevent chain-reaction liquidations and over-loss scenarios during periods of high volatility. By closing positions before they exhaust all margin, it protects both traders and the platform from extreme losses.
How does Auto-Deleveraging differ from regular liquidation?
ADL is triggered in exceptional circumstances when the risk reserve is critically low. Instead of waiting for market orders to match, the system directly closes positions of selected counterparties at the mark price, avoiding loss sharing among all users.
Can I avoid forced liquidation?
You can reduce the risk of liquidation by maintaining adequate margin levels, using stop-loss orders, and carefully monitoring your positions—especially during high-volatility events. Understanding margin requirements and tier thresholds is also essential.
What happens to my funds after liquidation?
After forced liquidation, any remaining margin from the liquidated position is returned to your account. If the liquidation results in a loss greater than your margin, the risk reserve fund covers the deficit, ensuring no debt is passed to you.
Is the risk reserve fund shared across different trading products?
No, risk reserves are typically isolated by product type (e.g., perpetuals, options) and by currency. This separation ensures that issues in one market do not affect others.
How often is the risk reserve updated?
The reserve is usually updated daily at a fixed time, with all liquidation-related gains and losses from the past 24 hours settled and reflected in the fund.