A liquidation is an order the engine sends to close a failing position. Like any order it needs a counterparty, and in a fast market it can fill worse than the bankruptcy price — the level at which the account’s margin is exactly exhausted.
That shortfall is real money and it has to come from somewhere.
First line: the insurance fund
Venues run an insurance fund, built up from liquidations that closed better than bankruptcy price, and it absorbs the ones that close worse. Most of the time this is invisible and works.
Its balance is usually published, which makes it a slow-moving read on how much stress the venue has been absorbing. A fund draining over a period of days is telling you something about conditions that the price chart alone does not.
Second line: auto-deleveraging
When the fund cannot cover the shortfall, the venue closes profitable positions on the opposite side to balance the book. This is auto-deleveraging, and it is the part worth understanding in advance, because it is the one moment where being right is not enough.
You are typically ranked by profit and leverage, and the most profitable, most leveraged accounts are deleveraged first. So a correct, well-timed, highly profitable trade can be closed against your wishes, at the mark, in the middle of the move that was proving you right.
Why it exists at all
Because a derivatives venue must stay balanced: every long is somebody’s short. If a losing side cannot pay, the gains on the winning side are not fully funded. Traditional markets solve this with clearing members and capital requirements. Crypto venues solve it with an insurance fund and, in the extreme, by socialising the shortfall onto winners — the broader subject of socialised loss and exchange risk.
The practical implication is narrow but real: in a genuine cascade, the counterparty structure itself becomes part of your risk, not just the price. It is one more reason a cascade is a different event from an ordinary large move.