Liquidations
When the account margin balance is less than the maintenance margin requirement, the account will be liquidated. Below are two liquidation methods that may be employed.
Traditional DeFi Approach: The liquidator takes over the position of the liquidated account and provides the required initial margin at the current mark price. After a successful liquidation, the liquidator will be rewarded with the balance of the maintenance margin. This method does not affect the market, since the only change in the entire system is the additional margin provided by the liquidator. However, liquidators are willing to provide such margins and endure risky positions that may not always be available. When such a liquidator appears, a complete liquidation is required.
Automated Liquidator Approach: Liquidations are typically handled in both traditional financial markets and CeFi exchange trades in the market. The purpose of this is to partially reverse the position of an account that falls below its maintenance margin requirement. Before the introduction of AMM, the availability of a counterparty made this partial liquidation strategy problematic within DeFi. However with the AMM, accounts that need to be liquidated can be forced to trade with the ALQ. Instead at the same time, with the respective AMM to partially reduce their positions to meet margin requirements. In this method, the settlement will impact the market, similar to traditional financial markets and CeFi exchanges. This method dramatically reduces the entry barrier for liquidations. It only requires the initiator to send the transaction to the smart contract, without providing any margin or taking up risk positions.
Leveraged trading relies almost exclusively on liquidation. When you open a leveraged position, you borrow money from the exchange to buy an asset with collateral.
If the asset's value decreases, losses begin to approach margin value (initial collateral). This puts the exchange at a relative degree of risk. While a rapid price fluctuation could reduce the value of your position to less than the provided collateral. Liquidation can be initiated when it satisfies the formula given below.
$AccountBalance + UnrealizedPnl
The protocol employed by fxdx supports both total and partial liquidation. Keepers on fxdx protocol will liquidate under-collateralized positions.
Partial liquidation occurs when the ratio of asset value to margin ratio is higher than 2.5%. Only 25% of the position will be liquidated, while the rest will remain unchanged while the margin ratio is higher than the liquidation point.
Total liquidation can occur if the price moves faster than liquidation and the margin ratio falls to 2.5% or less.