What a liquidation cascade is, in plain terms

A price falls. Some traders who borrowed to buy are forced to sell. Their selling pushes the price down further. That pushes more traders past their limits. This loop is a liquidation cascade. I wrote a working paper on a large crypto cascade in October 2025, and this post explains the mechanism without the details of any one event.

Step by step

Leverage. A trader puts up 100 of their own money and borrows another 900 to hold a position of 1,000. A 10 per cent fall wipes out the trader's money entirely.

Margin. To protect the lender, the exchange sets a maintenance requirement. If losses push the trader's equity below it, the position is in danger.

Liquidation. The exchange closes the position automatically, usually by selling into the market. The seller is not choosing a price. The system sells whatever it takes.

Thin books. Selling into a market with few buyers at nearby prices moves the price more than the same sale in a deep market. That extra move triggers the next trader's limit.

Backstops. Many exchanges keep an insurance fund to cover losses when a position is closed at a worse price than its limit. When the fund runs out, some venues use auto-deleveraging, which closes profitable positions on the other side. That can spread the shock to traders who did nothing wrong.

Why this is an old story

The mechanism is not specific to crypto. Economists describe it as the link between funding liquidity (how easily you can borrow) and market liquidity (how easily you can sell). Brunnermeier and Pedersen showed how the two reinforce each other. Shleifer and Vishny described fire sales, where forced sellers push prices below value and weaken other holders of the same asset.

The same pattern appears in margin calls on stock accounts, in bank balance sheets that depend on short-term funding, and in funds that hold assets that are hard to sell.

What to watch

• Leverage and open interest. High borrowing relative to equity means a small move can trigger forced selling.
• Order-book depth. Thin books amplify each forced sale.
• Concentration. Many traders with limits at similar prices create a cliff.
• Cross-market links. The same traders often hold positions in several markets, so selling in one can reach another.

Further reading

• Brunnermeier, M. and Pedersen, L. (2009). Market Liquidity and Funding Liquidity. Review of Financial Studies.
• Shleifer, A. and Vishny, R. (2011). Fire Sales in Finance and Macroeconomics. Journal of Economic Perspectives.