What is Liquidation?

Liquidation occurs when a leveraged position loses so much value that its remaining collateral drops below the exchange's maintenance-margin threshold. Rather than letting the account go negative, the exchange (or its liquidation engine) forcibly closes the position at or near the liquidation price, seizing the posted margin. On most perpetual venues an insurance fund absorbs any shortfall, and a liquidation fee is charged on top of the realized loss.

The trigger is the mark price, not the last-traded price. Exchanges deliberately liquidate against an index-based mark to prevent manipulation via thin order books — a single wick on one venue should not liquidate positions across the market. As unrealized loss grows, the margin ratio falls; once it hits the maintenance-margin level the engine steps in. Higher leverage shrinks the distance between entry and liquidation price, so a 20x position is liquidated by a much smaller adverse move than a 5x position.

For funding-rate arbitrage this matters even though the strategy is delta-neutral. A classic carry trade is long on one venue and short on another to collect funding while cancelling out price exposure. But each leg is margined separately: if the underlying rallies hard, the short leg accumulates unrealized loss and can be liquidated on its own before the offsetting profit on the long leg is credited to the same account. Cross-margin between accounts does not exist across two different exchanges.

This is why realistic sizing and margin buffers dominate arbitrage profitability. A position that shows an attractive annualized funding APR is worthless if a routine 8-10% swing liquidates one leg and converts a market-neutral trade into a directional loss plus liquidation fees. Arbitrageurs therefore run each leg at modest leverage, monitor per-leg liquidation prices, and top up collateral — the funding collected must comfortably exceed the cost of holding both legs safely away from their liquidation thresholds.