Hidden costs of crypto liquidation and how to avoid them

In the fast-moving world of digital assets, traders and investors often focus on potential returns, but understanding the risks of crypto liquidation is just as important. When markets turn volatile, liquidation can happen faster than expected, and the financial impact can extend beyond the obvious losses.

Whether you’re trading on margin, borrowing against your crypto, or simply exploring crypto-backed loans, it’s essential to understand how crypto liquidation works and the fees or other hidden costs that can quietly eat into your portfolio.

In crypto markets, liquidation occurs when your collateral is automatically sold by a platform to cover losses or repay a loan. This happens when the value of your collateral drops below the required maintenance threshold, often due to price volatility.

Here’s how it typically works:

• You borrow funds or open a leveraged position using your crypto as collateral.

• If crypto prices fall sharply, your collateral value decreases.

• When your collateral-to-loan ratio drops below the platform’s minimum requirement, liquidation is triggered automatically.

While liquidation helps protect lenders and platforms from losses, it is also designed to protect the borrower and prevent them from defaulting on their loan if that is possible (this is done by liquidating the crypto collateral to pay off the loan, so the borrower is left with no or the smallest balance possible given market conditions). Yet despite getting the benefit of having the loan paid off, liquidation may come at a significant cost to borrowers when it takes place.

Liquidation can be more expensive than most realize. Beyond the loss of your collateral, there are often hidden costs that amplify the financial hit.

Platforms may charge crypto liquidation fees when your position is forcibly closed. These can be much higher than regular transaction fees, as they cover the platform’s risk and operational cost of liquidating positions under stress.

When a liquidation occurs, assets are sold quickly and often at market prices. If liquidity is thin or the market is volatile, your crypto could be sold at a significantly lower price than expected.

Market spreads — the gap between buy and sell prices — often widen during liquidation events, further reducing the value you recover.

A forced liquidation means losing your position just as markets might rebound. Missing out on a recovery can be a major, though less visible, cost.

Liquidation can wipe out a large portion (or all) of your collateral. Because the sale happens automatically, you lose control over timing and execution.

Forced liquidations can also trigger taxable events. Even if you incur a loss, you may still be required to report the transaction depending on your jurisdiction.3

Here’s a simplified overview of how liquidation unfolds on most platforms:

1. You open a position or loan using crypto as collateral.

2. Market prices fall, lowering your collateral value.

3. The platform monitors your collateral ratio and issues a margin call (if applicable) prior to the collateral falling below the automatic liquidation threshold.

4. If your collateral falls below the maintenance threshold, liquidation is triggered automatically.

5. The platform sells your crypto — often quickly and at market prices — to cover the shortfall.

6. You’re charged fees, and if the sale doesn’t fully cover the balance, you may still owe the remainder.

Understanding how liquidation works in crypto is key to recognizing when you’re at risk and how to protect yourself before it happens.

While you can’t completely eliminate market risk, there are steps you can take to reduce the likelihood and cost of liquidation.

• Maintain strong collateral ratios: Keep your loan-to-value (LTV) comfortably below the platform’s maximum limit. A healthy buffer helps absorb volatility.

• Use lower leverage: High leverage magnifies gains, but also accelerates liquidation risk.

• Know your platform’s terms: Understand how liquidation thresholds, fees, and triggers are defined before borrowing or trading.

• Act early: If markets are turning, manually reducing exposure can save you from automatic liquidation.

• Diversify collateral: Using multiple assets helps cushion volatility in any one coin.

• Monitor market volatility: Setting alerts for large price swings or changes in your LTV can give you time to respond.

• Consider risk-mitigation features: Some platforms, such as Figure, now offer liquidation protection options. You pay a small fee or premium, and if the market drops sharply, the provider absorbs the loss instead of liquidating your assets.

Such liquidation protection can be particularly valuable for long-term holders who want to maintain positions without constantly monitoring price movements. It doesn’t remove all risk, but it can help reduce the emotional and financial stress of sudden sell-offs (collateral can still be liquidated if the borrower fails to make their regularly scheduled payments and defaults on the loan).

Liquidation isn’t just a technical event; it’s often an expensive lesson in how crypto markets handle risk. By understanding what liquidation looks like in crypto, how the liquidation process works in crypto, and the crypto liquidation fees and hidden costs involved, you can make smarter borrowing and trading decisions.

Simple steps like maintaining healthy collateral ratios, acting early during downturns, and exploring tools such as liquidation protection can go a long way toward safeguarding your assets.

If you’re considering borrowing against your crypto, Figure’s crypto-backed loans are designed with transparency and borrower protection in mind — including access to Liquidation Protection, which helps reduce the risk of your assets being automatically sold off if prices drop. Liquidation Protection is currently available in California, Florida, New York, and Pennsylvania.

By staying informed, proactive, and protected, you can make the most of your crypto holdings while minimizing the hidden costs of liquidation. More information on liquidation protection can be found here.

Liquidation occurs when the value of your collateral drops below the platform’s required maintenance margin or loan-to-value ratio. It can also be triggered if a Borrower defaults on a crypto-backed loan by failing to make their regularly scheduled payments.

Fees vary by platform but are generally higher than normal transaction costs due to the added operational risk of liquidating assets.

Not entirely, but you can greatly reduce the risk by keeping your LTV low, monitoring prices, and using protection tools designed to absorb volatility.

Liquidation protection can reduce the likelihood of forced liquidation during sudden market drops, but it’s not a guarantee since crypto can still be liquidated if the Borrower defaults on their loan. It’s best viewed as a service purchased to acquire a specific benefit (the liquidation protection). Liquidation is not a replacement for strong risk management and will not prevent liquidation if a Borrower defaults on their loan or violates the terms of their loan agreement.