Contract Trading Liquidation Mechanisms: How to Distinguish Between Liquidation, Position Closing, and Bankruptcy?

Many beginner traders have a poor understanding of concepts like liquidation, closing positions, and穿倉 (crossing the line), especially regarding the flow of funds after liquidation. This article will analyze these concepts from the perspective of fund flow, exploring their fundamental differences and the core role of the closing mechanism in risk management.

When a contract is liquidated, where do your losses go?

Many traders wonder: who profits from the liquidation of a contract? In fact, this involves several aspects:

Counterparty profits:

• The funding rate of perpetual contracts all goes to the counterparty, regardless of whether the price moves up or down; funding payments are direct transfers of benefit.
• The loss on the margin (principal) before liquidation is also earned by the counterparty. In other words, your loss is their gain.

Platform earnings:

• Extra losses during穿倉 (crossing the line) are borne by the platform. In volatile market conditions, the platform may profit; but in unidirectional markets, the platform could incur more losses or even transfer funds to the counterparty.
• All transaction fees are collected by the platform, which then shares a portion with market makers as incentives.

Important clarification: Exchanges never actively take the opposite side of trades. The role of the market maker is always played by liquidity providers, not the platform’s reserve funds. The platform’s core business is matching trades and collecting fees, not gambling against users.

The relationship between funding rates and closing positions: the hidden costs of perpetual contracts

Perpetual contracts are called “perpetual” because they have no delivery date; instead, they are anchored to spot prices through funding rates.

How funding rates work: The goal of perpetual contracts is to keep the contract price close to the spot price. To achieve this, exchanges adjust the funding rate. The rules are as follows:

• If the funding rate is positive, long users pay short users.
• If the funding rate is negative, short users pay long users.
• Payments are typically settled every 8 hours.

Calculation formula for payment: Payment = Trading volume (principal × leverage) × funding rate

For example, if you invest 10,000 yuan with 10x leverage to hold a long position, your trading volume is 100,000 yuan. If the funding rate is 0.01%, then every 8 hours, you pay 100,000 × 0.01% = 10 yuan. Although the cost per period seems small, holding positions long-term can accumulate significant costs. This is why traders should regularly evaluate whether to close their positions to avoid continuous funding costs.

Why is liquidation so easy? Hidden risks of leverage and fees

Many newcomers are prone to liquidation when trading contracts, mainly due to improper use of leverage.

Leverage as a double-edged sword: Leverage amplifies both gains and risks. For example, with 100x leverage, a 1-point price move can double your profit—or your loss. Contract leverage can be set between 1x and 125x. Many traders, after losing with low leverage, tend to increase leverage further, eventually leading to liquidation. Therefore, controlling leverage within reasonable limits is key to avoiding liquidation.

Ongoing fee costs: Using a well-known exchange as an example, the fee structure is as follows:

• Taker (immediate execution) fee: 0.05%
• Maker (limit order) fee: 0.02%

Fees are charged on both buy and sell sides. Frequent trading causes fees to accumulate quickly.

Fee calculation formula: Fee = Trading volume (principal × leverage) × fee rate

For example, with 10x leverage and a 5,000 yuan buy order, the trading volume is 50,000 yuan. The fee is 50,000 × 0.05% = 25 yuan. If you then close the position (sell), another 25 yuan fee applies. The total cost for a complete buy-sell cycle is 50 yuan, about 1% of the principal. Under high leverage, the proportion of fees becomes even more significant.

Active closing vs. forced liquidation: key to risk management

Understanding the two types of position closure is crucial for risk control.

Advantages of active closing: Traders can choose when to close based on market trends, funding costs, or personal risk appetite. Active closing offers greater flexibility, allowing traders to cut losses early or lock in profits when satisfied.

Forced liquidation and ADL (Auto-Deleveraging) mechanisms: When margin becomes insufficient to maintain a position, the system automatically triggers forced liquidation. Modern exchanges often implement ADL, prioritizing closing the highest-risk, highest-leverage positions to prevent sudden穿倉 (crossing the line) that could cause the platform significant losses.

In short, ADL is a protective measure designed to prevent extreme market moves from causing widespread穿倉. While forced liquidation is not the trader’s choice, the presence of ADL ensures market stability.

Practical risk management suggestions

Based on the above analysis, traders should:

1. Set leverage reasonably — beginners should start with low leverage (e.g., within 5x) and gradually increase with experience.
2. Monitor funding rates continuously — consider closing positions if funding costs become too high to avoid ongoing expenses.
3. Calculate total costs — include fees, funding costs, and slippage, as they all impact actual returns.
4. Set stop-loss levels — active closing is always better than passive liquidation; having clear stop-loss plans helps control risks.

Perpetual contracts offer high-profit opportunities but also come with high risks. Understanding the differences between liquidation, closing, and穿倉, as well as mastering the mechanics of funding rates and leverage, are fundamental to achieving consistent profits in contract trading.