The crypto market often experiences two opposing forces. When prices rise, traders get excited and borrow heavily to amplify their gains. However, when volatility increases and prices fall, there’s a lack of available funds, leading to significant losses for those who borrowed.
Recently, we’ve noticed that most liquidations during market drops are happening with long positions, both in lending and perpetual futures. This is important because these liquidations often trigger further sell-offs – when an account’s collateral gets low, liquidators quickly step in to close the position.
This article explains why long-term investments are often the most vulnerable part of a portfolio, what recent market drops showed us, and how to prevent normal price fluctuations from turning into major losses.
Here’s a breakdown of key risks in volatile markets:
Recent market drops primarily impacted those betting on price increases (long positions), suggesting many traders were overly optimistic. When volatility increases, funding dries up quickly as lenders withdraw stablecoins and traders reduce their available assets, leading to fewer buyers just as margin calls start happening. DeFi protocols automatically close positions when certain price levels are hit, and incentives encourage rapid selling by automated trading bots. Positive funding rates for long positions can quickly turn negative as prices fall, forcing both hedged and speculative traders to reduce their exposure. Ultimately, smart risk management – including careful position sizing, low loan-to-value ratios, diversified collateral, and proactive alerts – is more important than any investment thesis when markets become unstable.
How Long Leverage Amplifies DeFi Liquidation Loops
Throughout the first half of 2026, risk managers repeatedly emphasized that the real issue wasn’t the price changes, but the lack of available funds to trade. Following the exploit affecting LayerZero and KelpDAO, I observed funds leaving Aave and talked to traders who switched from long-term, leveraged positions to quicker, short-term hedges. The sharp price drops in late May, which hurt many long positions, aligned with what options traders had predicted—too many people betting on prices going up with limited trading activity outside of regular hours. I don’t believe this will eliminate leverage in DeFi, but it will change how people use it: smaller trades, more collateral to cover potential losses, and plans to add more margin if needed. Those teams who had prepared for these scenarios handled the recent volatility much more smoothly. — Sophia Bennett
In the crypto world, leverage is commonly used in two main ways: borrowing crypto to trade (using assets like Ethereum as collateral for stablecoins), and through perpetual futures contracts that use margin. In both cases, traders tend to favor positions that bet on the price going up. This is because of factors like limited availability of certain coins, rewards for holding crypto (staking), and a general tendency for investors to be optimistic during bull markets, all of which push them towards expecting price increases.
Collateral volatility meets fixed thresholds
DeFi lending platforms use collateral factors and liquidation thresholds to manage risk. If the price of your collateral drops, its value decreases relative to your loan. When this value falls below a certain point, some of your collateral is automatically sold – often quickly and at a reduced price – to cover your debt. This process isn’t based on opinions about the asset’s potential; it’s purely based on numbers.
Liquidation bots don’t hesitate
When a project faces liquidation, professionals are ready to quickly buy up its assets and credit, incentivized by extra rewards. If there isn’t much backing the project, even small sell-offs can drive prices down, causing more accounts to fall below required levels – similar to a dangerous cycle where falling prices trigger more selling in traditional finance.
Perps magnify the move
With continuous trading platforms, holding long positions with borrowed funds can lead to losses if the price goes down. If the price drops quickly, traders may run out of funds to cover their positions before they can respond, particularly when borrowing costs increase or there’s a lack of available buyers and sellers. These sudden, forced sales then worsen the price decline and increase the difference between the expected price and the actual price at which trades are executed.
A smart move: think of liquidation levels as sudden drops, not gradual slopes. Protect yourself by keeping your loan-to-value ratio low and having extra buffer, instead of trying to react quickly when prices change.
Fresh Stress Signals: What May’s Liquidations Tell Us
The crypto market experienced a sudden and significant downturn in late May, demonstrating how quickly things can change. On May 28th, nearly $959 million worth of crypto trades were closed out, largely affecting those who bet prices would rise (long positions) – around $897 million of the liquidations were from longs, compared to just $61 million from those betting on price drops (shorts). This event was triggered by news related to global political events, and it clearly showed a strong impact on traders who were expecting prices to go up (CoinDesk).
Recently, traders betting on future price increases lost approximately $563 million in a single day, specifically during the week of May 17th. Bitcoin and Ether experienced the biggest losses, according to CoinDesk. This highlights a pattern: when the market becomes unstable, those who have made large bets that prices will rise are often the first to suffer significant losses.
These numbers don’t necessarily indicate a fundamental shift, but they fit the existing pattern: a lot of risky investment when things are stable, and then a reduction of debt when problems arise.
Liquidity Is Thinner Than It Looks
Immediately after the recent LayerZero/KelpDAO security incident, major lending platforms and perpetual futures markets experienced a rapid decrease in available funds. According to Galaxy Research, Aave alone saw over $5.5 billion in stablecoins withdrawn and $3.1 billion in stablecoin loans closed within two weeks. Additionally, over 25,400 Bitcoin and more than 943,000 WETH were also withdrawn from the platform (Galaxy Research).
Investor willingness to take risks decreased around the same time. Between May 20th and 26th, investment products tracked by CoinShares saw roughly $1.47 billion in net outflows—the largest weekly decrease this year—indicating that institutions were pulling their money out of the market, according to Yahoo Finance and CoinShares data.
When both lenders and investors pull back, the financial system becomes more vulnerable. Lending standards get stricter, the value of collateral backing loans decreases, and financial firms have to hold onto more risk themselves. This creates a situation where further market declines are more likely to happen – and happen quickly.
If those who provide buying and selling opportunities increase their prices or stop offering them altogether, any attempt to sell assets quickly will cause prices to drop more significantly. This is why using borrowed money can be profitable, but it eventually stops working when market conditions change.
Practical Risk Controls for DeFi Borrowers and Perp Traders
A borrower’s checklist
- Target conservative LTV. If a protocol liquidates at 75% LTV, operate at 50–55% to withstand sudden 20–30% swings.
- Diversify collateral. Mix assets with different vol profiles; avoid single-asset concentration that shares one narrative risk.
- Know oracle cadence. Understand price feed latency and medianization rules; fast drops plus slow oracles can distort liquidation timing.
- Automate alerts. Health-factor or LTV alerts via bots keep you ahead; don’t rely on push notifications alone.
- Keep dry powder. Maintain spare stablecoins or collateral to top up; plan the size of “rescue” adds before stress arrives.
- Mind stablecoin risk. Even major stables can depeg or face liquidity frictions exactly when you need them most.
For perp and futures traders
- Lower gross leverage. Size positions assuming a multiple standard-deviation move can arrive overnight.
- Prefer isolated margin for higher-risk bets; cross margin hides risk concentration and can drain your entire wallet.
- Use stop-loss and take-profit brackets. In whipsaw tapes, “mental stops” are not a plan.
- Track funding and basis. Rich long funding is a crowding tell; if it collapses, longs can face both PnL and cash-flow reversal.
- Stagger entries. Laddering reduces the odds of catching a local top, and gives more room before liquidation levels converge.
- Consider options for downside hedging. Puts or collars can cap tail risk; premium costs are explicit and often cheaper than forced liquidations.
Here’s a helpful tip: Test how your investment would handle a significant downturn. Imagine it loses 25% of its value and becomes harder to sell. Do you have enough funds set aside and a strategy to weather the storm? If not, consider reducing your position size.
Comparing Liquidation Engines Across Protocol Types
Here’s a breakdown of risks for long positions in different DeFi venues:
DeFi Lending (Overcollateralized Pools): If the price of your collateral drops (as measured by the ‘oracle’ price), your position might become undercollateralized. This can trigger partial liquidations, where your collateral is sold at a discount to repay your debt. Risks include inaccurate price feeds, low buying activity on the blockchain, and excessive selling pressure.
Collateralized Debt Positions (CDPs): If your debt exceeds the value of your collateral, an auction is triggered to sell your collateral. This can happen with ‘slippage’ (selling at a lower price than expected) and the need to pay a premium for quick execution, potentially destabilizing the debt asset.
Perpetual Decentralized Exchanges (Perpetual DEXs): If your margin falls too low, your position will be closed automatically through the exchange’s automated market maker (AMM) or order book. Price differences between the AMM or gaps in the order book can worsen the impact.
Centralized Perpetual Exchanges: If your maintenance margin is breached, the exchange will automatically reduce your position (auto-deleveraging) or use an insurance fund. Extreme market movements can create long queues for deleveraging.
Options (as a Hedge): Buying options requires paying a premium upfront, but there are no margin calls. Your maximum loss is the premium paid. However, if the underlying asset’s price moves sharply away from your strike price, or if you can’t find enough buyers when you want to exit, you could face losses.
The way these systems sell off assets is always predictable. What changes is the price those assets fetch and how much available supply there is when the sale is triggered.
Case Study: A Crowded ETH Long and the Domino Effect
- Setup: ETH rallies for weeks. Funding stays positive, open interest climbs, and borrowers lever spot by minting stablecoins against staked ETH.
- Shock: A macro headline hits during off-hours. Liquidity providers step back; bids thin.
- First breach: Perp longs get clipped; isolated liquidations print into a shallow book, pushing price into on-chain liquidation bands.
- On-chain unwind: Borrowers near threshold face keeper liquidations. Liquidators sell collateral quickly to capture bonuses, deepening the slide.
- Feedback: Funding compresses; some venues flip negative. Borrowers race to repay but face slippage and wider spreads.
- Aftermath: Surviving positions reduce leverage. New collateral factors may tighten, and borrow APRs rise, deterring re-risking.
None of this requires a crash—only a sharp enough move during an illiquid window.
Common Mistakes That Turn Volatility Into Losses
- Running max collateral ratios “because it worked last month.” Regimes change, sometimes overnight.
- Using one asset as both collateral and directional bet. Correlation spikes in stress.
- Ignoring oracle and auction mechanics. The rules decide outcomes; read them before depositing.
- Funding complacency. High positive funding is a crowd signal; when it collapses, longs feel it twice.
- Cross-margining everything. A single bad trade shouldn’t consume the entire account.
- Counting on manual adds. If your plan requires you to be awake at 3 a.m., it isn’t a plan.
What to Watch Next: Indicators of Rising Liquidation Risk
- Funding extremes and basis spreads. Stretched positive funding often precedes long-heavy wipeouts.
- Borrow rates and collateral factor changes on major lenders. Tightening is an early warning of risk aversion.
- Stablecoin net flows into/out of lending pools. Large outflows signal thinner rescue liquidity and higher odds of on-chain unwinds.
- Open interest versus spot volume. High OI on declining spot volume suggests positions are vulnerable to a single catalyst.
- Order-book depth snapshots around key levels. Depth “air pockets” mark where cascades can accelerate.
- Macro headlines during crypto’s illiquid hours. Off-session catalysts hit harder.
Here’s a helpful tip: Use online tools to track potential liquidation levels for your crypto assets. When the price gets close to a significant liquidation zone, consider reducing your risk proactively instead of waiting for a sudden price drop.
Stay Informed with Crypto Daily
As an analyst, I’m constantly monitoring how the crypto market is changing, and I find Crypto Daily at cryptodaily.co.uk to be a valuable resource. They provide regular updates on market structure and potential risks signaled by on-chain data. Specifically, I appreciate that they track the build-up and release of leverage, which helps me understand where we are in the market cycle and make more informed decisions.
Frequently Asked Questions
Why are long positions more frequently liquidated than shorts in crypto?
Cryptocurrency markets tend to go through periods where investors are optimistic and heavily invested. This means many traders are taking on long positions (betting prices will rise). When something unexpected happens, these positions are usually larger and more highly leveraged, leading to quicker and more significant price drops than we typically see when people are betting against the market.
What connects lending-pool outflows with perp liquidations?
When lenders take out their stablecoins, the safety nets protecting loans decrease. If traders simultaneously sell their positions, borrowers struggle to add funds or pay back what they owe. This combination can turn a small price drop into a larger sell-off across different trading platforms.
How do liquidation bonuses impact the depth of selloffs?
As an analyst, I’ve observed that bonuses encourage immediate liquidations, which can be a double-edged sword. When the market faces stress, numerous automated bots jump in to sell assets quickly, but this happens as available liquidity decreases. While this rapid action helps keep the protocol solvent, it often drives prices down, triggering liquidations across multiple price levels.
Is using stablecoins as collateral safer?
Stablecoins help lessen the price swings of assets used as collateral, but they also introduce new potential problems like losing their value peg, facing sudden shortages of available coins, and risks related to the companies that issue them or the platforms connecting them. Even with stablecoins, it’s still important to spread out your investments and avoid overly large positions.
Can options reduce liquidation risk on leveraged longs?
Using long puts or collars can limit potential losses without triggering margin calls on the options. However, this strategy involves paying a premium and carries the risk of unfavorable pricing if the underlying asset’s price jumps significantly.
Which data points signal a looming liquidation wall?
Pay attention to significant shifts in funding rates or basis, the relationship between open interest and trading volume, adjustments to collateral requirements, and tools that show how many users are at risk of liquidation based on current prices.
What did May’s wipeouts reveal about market structure?
Towards the end of May, there was a large wave of liquidations – roughly $897 million worth of long positions were closed in a single day. This happened alongside withdrawals from lending platforms and investors redeeming their products, highlighting how quickly things can dry up when major economic events occur.
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2026-05-29 20:31