DeFi

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<p><strong>Before we get into the details of avoiding or minimizing <a href="https://yellow.com/tag/defi" rel="noopener noreferrer nofollow">DeFi </a>liquidations let's first understand what it is and how it works.</strong></p>
<h2 id="what-is-defi-liquidation">What is DeFi Liquidation?</h2>
<p>In simple terms, liquidation is the process of not being able to hold a leverage position because of the absence of sufficient funds. Crypto traders face liquidation when they are unable to fulfil the margin requirements for leveraged positions which essentially means they have run out of funds to keep the trades open. To avoid this you need to have critical strategies in place while you trade so that you can leverage them in future.</p>
<p>In <a href="https://www.coinbase.com/learn/advanced-trading/what-is-defi-liquidation" rel="noopener noreferrer nofollow">Decentralized Finance</a> (DeFi) traders access borrowing agreements outside of traditional finance by putting up crypto assets as collateral. But, they have to remember the volatile nature of digital assets which can often lead to liquidation of their agreements. In such a situation, traders lose their collateral which heightens the risks of the DeFi space and the trader.</p>
<p>DeFi liquidation happens when the borrower’s collateral mentioned in the agreement goes below a particular threshold, making it a risky position for both parties because of crypto market volatility. To lower the risk of DeFi liquidation, traders need to maintain a margin between asset borrowing and their collateral.</p>
<h2 id="ways-to-avoid-defi-liquidation">Ways to Avoid DeFi Liquidation</h2>
<p>The volatile nature of the crypto market makes it difficult to accommodate slight variations in the price, which leads to liquidation and losses. To counter this and ensure that DeFi liquidation risks are curtailed, traders need to opt for <a href="https://www.binance.com/en-IN/blog/futures/six-strategies-to-minimize-liquidation-risks-in-crypto-futures-5627950652009685181" rel="noopener noreferrer nofollow">certain strategies. </a></p>
<h3 id="1-build-a-proper-trading-plan">1. Build a proper trading plan</h3>
<p>The first and foremost strategy is to plan your trades ahead of time to reduce liquidation chances. This includes devising a plan that takes into account losses in case of liquidation and a proper exit strategy when the market goes down.</p>
<p>This will prevent impulsive buying due to greed or fear emotions, removing any temptation to retain positions for too long. All this makes traders exit the game when it is time not too soon without any leveraging much profits.</p>
<h3 id="2-secure-trading-positions">2. Secure trading positions</h3>
<p>The crypto market is always up for fluctuations and despite the best precautions the price can go in unintended directions. Hence, traders need to align their trading positions along the price chart such that they have an exit strategy which prevents liquidating their position if the market goes the opposite way.</p>
<p>For this crypto traders mark a range or level where they can exit the trade. However, this alone isn’t enough it’s feasible to use a stop-loss order to make the exit plan more effective in reducing losses</p>
<p>This stop-loss order is the exact price where a trade will automatically exit if the cryptocurrency goes down to a pre-determined level. However, stop-loss orders are not a foolproof solution to protect against liquidation. In case, the liquidation price fluctuates then stop-loss orders might fail to prevent liquidation.</p>
<h3 id="3-maintain-the-margin">3. Maintain the margin</h3>
<p>As mentioned earlier the key to mitigating DeFi liquidation risk is to maintain the margin which is the minimum amount needed to keep the trade open. There’s also a margin balance which shows the funds available in the account.</p>
<p>When the margin balance goes below the maintenance margin the crypto exchange will automatically close the leveraged positions in order to restrict losses. Hence, crypto traders should maintain the margin to avoid liquidations.</p>
<p>When a price declines significantly, traders need to maintain enough margin balance to keep the trade open. The higher the margin balance, the lower is the liquidation price.</p>
<h3 id="4-practice-your-trading">4. Practice your trading</h3>
<p>Traders should familiarize themselves with mock trading where they test their trading tools and strategies and gain experience. Testnets are useful in this regard as they provide the opportunity to practice in real-time without risking capital.</p>
<h3 id="5-proper-utilization-of-risk-management-strategies">5. Proper utilization of risk management strategies</h3>
<p>Risk management is a key aspect of crypto trading and one of the essential strategies to manage risks is to limit exposure on any particular trade. Traders shouldn’t risk over 1-2% of their trading account balance on a single trade.</p>
<p>If the trader has $10,000 balance in their account then they shouldn’t risk more than $100-200 per trade as they will lose only a small portion if it goes wrong. Ideally, it is best to leverage 2x-5x and avoid getting into multiple trade contracts.</p>
<p>Large positions where 1-2 bad trades can wipe out balances are best avoided instead it is better to start slow and develop a method of trading that doesn’t involve large positions.</p>
<h3 id="6-restrict-compounding-losses">6. Restrict compounding losses</h3>
<p>Traders should restrict investing in positions that are losing trade. Say they have invested in a contract whose value is on the decline, it is wise not to invest further in the same contract.</p>
<p>Investing in losing positions reduces the liquidation price and increases the potential for liquidations. Traders should instead think of cutting losses by shutting down losing positions and focusing on lowering risks. They can also avoid liquidation by adding more contracts or averaging down.</p>
<h3 id="7-avoid-overtrading">7. Avoid Overtrading</h3>
<p><a href="https://www.coinglass.com/ru/learn/learn-46" rel="noopener noreferrer nofollow">Overtrading </a>or constantly indulging in buying and selling to make profit often act as a trap for liquidation as it leads to high trading costs. Hence, traders need to develop a proper trading strategy and stick to it to prevent excessive trading and getting swayed by market emotions.</p>
<h3 id="8-reduce-blindly-following-hotspots">8. Reduce blindly following hotspots</h3>
<p>Lastly, crypto traders should do their own research and follow a trading plan instead of blindly following hotspots and investing in popular trades to make profits. This blind following of trends results in heightened risks, making them lose their rationality and power of choosing. Instead, conduct thorough research to identify trading opportunities and devise a proper trading plan to gain profits.</p>

Eight Strategies To Avoid DeFi Liquidation Risks

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