Cascading liquidation refers to an event where liquidations pile on top of each other, resulting in a sudden price change.
Cascading
liquidations usually coincide with an over-heated or over-leveraged market. Like with other investments, cascading liquidations in
cryptocurrency can result in either massive losses or tremendous profits.
Most investment platforms use
margin calls that are above the investor's liquidation price to give them time to add collateral to their position and avoid getting liquidated. When taking a loan against crypto, say,
Bitcoin, you are given the liquidation price upfront depending on the worth of your collateral and the number of tokens you are taking.
If it so happens that the market price drops and things don’t go as planned, most lending protocols start to sell parts of your collateral to cover the amount.
Unfortunately, this increases the selling pressure as these liquidations happen. It also creates a compounding effect causing more people to get liquidated as new lows are reached. Suddenly everyone in the market is panicking because they need to cover their loan and avoid liquidation. Cascading liquidations tend to have a ripple effect; other coins get sell pressure, and loans against these coins start to liquidate.
Cascading liquidations are common in a
bear market because of low investors' confidence. Therefore, they keep their positions closed, take profits, and move money into less risky investment options. This usually creates sell pressure across all markets. At this point, some traders opt to
leverage their
portfolios in order to amplify their gains. Unfortunately, some of them get liquidated by the initial selling pressure, and these liquidations create a cascading liquidation event.
In order to successfully counter cascading liquidations, you must avoid leverage at all costs unless you are fully aware of what you are doing and all the possible risks involved.
When entering into a new project, it is better to utilize
dollar-cost averaging. You can then hold these tokens and find ways to earn more tokens without risking your portfolio. This is where
staking comes in handy.