Spot & Futures 101 · Chapter 5
Liquidation & the funding rate
Two mechanisms hold the perpetual market together. One removes positions that can no longer pay for themselves; the other keeps the contract's price tied to the asset it is supposed to track. Between them they explain most of the violent moves you see on a crypto chart.
Liquidation
Your liquidation price is the level at which unrealized losses have eaten your margin down to the maintenance requirement. Cross it and the exchange closes the position for you — not as a punishment, but because your collateral can no longer cover the loss, and someone has to be made whole.
Roughly, the distance to that level is your margin minus the maintenance requirement, divided by position size. At 10x it lands about 9–10% away; at 20x, about 4.5–5%. Adding margin pushes it further away, taking size off does the same, and unrealized profit widens the buffer while it lasts.
Note what gets measured: the mark price, an index built from several spot venues, not the last trade on the exchange you happen to use. That is deliberate — otherwise a thin book could be pushed a few percent for a moment and liquidate everyone on the venue.
Being liquidated is not break-even: you lose the margin, pay a liquidation fee, and if the position closes worse than expected the insurance fund absorbs the rest — with auto-deleveraging as the last resort, which can close profitable counterparties on the other side. A stop-loss placed before that point is always the cheaper exit.
Why cascades happen
A liquidation is not a quiet accounting event — it is a market order. Liquidating longs sells into the book, which pushes price down, which reaches the next cluster of liquidation prices, which sells again. Leverage tends to concentrate around round numbers and obvious levels, so the fuel comes in clumps.
That is the anatomy of the 10% candle that appears in minutes and retraces half of it just as fast: forced sellers with no price sensitivity, hitting a book that thinned out the moment volatility spiked. The same loop runs upward through short liquidations — a short squeeze — and it rhymes closely with the dealer-hedging loop behind a gamma squeeze.
The funding rate
A perpetual has no expiry to force convergence with spot, so it needs a substitute. Funding is a payment exchanged directly between longs and shorts — the exchange only routes it — typically every eight hours.
When the perp trades above spot, funding is positive and longs pay shorts. Holding the crowded side now has a running cost, and taking the other side earns a yield; both pressures push the contract back toward spot. Below spot the sign flips and shorts pay longs. The rate itself is usually a small premium component plus a fixed interest component, capped by the exchange.
The amounts look trivial and compound anyway: 0.01% per 8h is about 11% annualised, and in an overheated market funding can sit at 0.1% or more per interval — over 100% a year. A directionally correct position can still bleed out paying for the privilege of being early.
Funding as a positioning signal
Because funding is the price of crowding, it reads as a sentiment gauge. Sustained high positive funding alongside rising open interest says the market is long, leveraged and paying for it — conditions where a modest dip finds liquidations underneath. Deeply negative funding says the opposite, and is often where short squeezes are born. Neither is a timing tool on its own; both tell you which direction the market is fragile in.