How to Avoid Liquidation: Insurance Funds, ADL, Oct 10
Lesson 5 of 9 · Intermediate
What is liquidation? From maintenance margin to forced closing
Liquidation means the exchange closes your leveraged position without your consent because losses have grown so large that the remaining margin no longer meets the minimum requirement (the maintenance margin). The exchange aims to close the position before its loss exceeds your collateral, because beyond that point someone has to cover the shortfall.
Separate two prices:
- Liquidation price: where the exchange's engine starts closing the position. It is usually measured against the mark price.
- Bankruptcy price: where the position's entire margin reaches zero. The gap between the two is the maintenance margin.
On most exchanges, when you are liquidated the remaining margin is usually lost too, or a large part of it goes to liquidation fees. Some exchanges reduce large positions in steps (partial liquidation), but the outcome for the trader is almost the same: a realised loss, at the worst price of the moment.
The liquidation price is not fixed either. In isolated mode, funding payments and fees bring it closer, and adding margin pushes it further away. In cross mode, each position's liquidation price depends on the profit and loss of all other positions and the value of every collateral asset, so a position whose price has not moved can be liquidated because of a loss elsewhere or a fall in the value of a collateral asset. The number you saw when opening the position is only a snapshot of that moment.
Insurance funds and ADL: when a shortfall must be covered
The liquidation engine closes your position in the market. If the execution price is better than the bankruptcy price, the surplus normally goes to the exchange's insurance fund. If the market moves so fast, or the order book is so thin, that execution is worse than the bankruptcy price, the shortfall is paid from that fund so the winning counterparty can collect their profit.
What if the insurance fund is not enough? That is where ADL (auto-deleveraging) comes in: the exchange forcibly closes some or all of the positions of profitable traders on the opposite side, at a set price, to cover the shortfall. Priority usually goes to those with the most profit and leverage. Many exchanges show an ADL queue indicator on the position.
The important consequence: even a winner carries risk. ADL can close your profitable position at a moment you did not choose. If that position was a hedge for another (for example, a perp short against spot Bitcoin), your hedge suddenly disappears and you are exposed to price movement.
How does a liquidation cascade form?
Liquidation is a forced market order. Liquidated longs mean selling into the market; that selling pushes price lower and brings the next longs to liquidation. This loop is called a liquidation cascade:
- Price reaches a zone where many highly leveraged positions are liquidated.
- Liquidation engines send market orders and consume the order book's liquidity.
- In volatile conditions, market makers reduce or pull their orders, and the book becomes thinner.
- Price moves with more slippage and the next wave of liquidations triggers.
The same logic works upward through short liquidations. A cascade is more dangerous when OI and system leverage are high and the collateral assets are themselves volatile.
The October 10, 2025 lesson
The crash of October 10, 2025 is a textbook example of every mechanism in this lesson. According to CoinGecko, more than $19 billion of positions were liquidated in about 24 hours, affecting more than 1.6 million accounts.
A less noticed element of that day was oracle and collateral risk at the exchange level. According to 21Shares' analysis, the synthetic stablecoin USDe fell to about $0.65 on Binance's order book while on-chain liquidity pools stayed close to $1. Accounts that used USDe as collateral were valued using that exchange's own order book price, so the value of their collateral dropped suddenly and some were liquidated even though their positions were not in trouble on their own.
The lessons:
- "Nearly a dollar" collateral on one exchange is not the same as a dollar; its value depends on the price source the exchange uses.
- In cross or unified margin mode, a fall in one collateral asset can liquidate the whole account.
- On crisis days, order books empty out and stops execute with heavy slippage.
- Winners can also be forced out through ADL.
Risk warning: how to reduce liquidation risk
Risk warning: any leveraged position can be liquidated and its entire margin lost; in cross or unified margin mode the whole account is at risk. This lesson is educational. The principles below reduce risk; they do not remove it:
- Keep the effective leverage of the whole account low.
- Place your stop well before the liquidation price, and accept that in crisis conditions it may execute with slippage.
- Do not use volatile or synthetic collateral for leveraged positions unless you fully understand its valuation risk.
- Do not keep all your assets on one exchange; counterparty risk is part of liquidation risk. Users in sanctioned regions face an added risk of account or asset freezes on some platforms.
Common mistakes
- Assuming a stop always executes exactly at the set price, even in a liquidation cascade.
- Using synthetic stablecoins or volatile tokens as collateral on the assumption that they are "like dollars".
- Ignoring ADL and assuming a profitable position carries no risk.
- Placing the stop so close to the liquidation price that slippage triggers both together.
- Using cross or unified margin for every position without understanding that one asset can put the entire account at risk.
What do volume and data say here?
Liquidations leave a clear footprint in market data that you can read yourself:
- Volume spike + sharp OI drop: the usual signature of a liquidation cascade. OI that collapses within minutes means positions were closed by force.
- CVD during the cascade: forced market orders push CVD sharply one way. Afterwards, look for absorption: large resting limit orders that take the pressure without price moving further.
- Price gaps between exchanges: on days like October 10, an asset's price diverges between exchanges, or between an exchange and on-chain venues. Comparing them shows whether the problem is the whole market or a single order book.
This data is excellent for understanding an event after it happens, but it does not predict the timing of the next cascade.
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Frequently asked questions
What is liquidation in simple terms?
The exchange force-closes your leveraged position because its loss has reduced the remaining margin below the minimum required. In that case you usually lose the entire margin of that position.
What is ADL and why was my profitable position closed?
When an exchange's insurance fund is not enough to cover liquidation shortfalls, the exchange automatically closes some profitable positions on the opposite side. Priority usually goes to highly profitable, highly leveraged positions.
How do I avoid liquidation?
No method is guaranteed. Low effective leverage, a stop placed before the liquidation price, small size relative to the account, and avoiding volatile collateral reduce the risk. The simplest way to remove it completely is not to use leverage.
Education only, not a recommendation to buy or sell; we never give signals. Price examples are illustrative. Test any method on a demo account first, with strict risk management.