How soft liquidations affect the cryptocurrency market

When people talk about liquidations* in the cryptocurrency market, they usually refer to the forced closure of a leveraged* trading position. Such events are typically accompanied by significant price swings and surging trading activity and are quickly reflected in the statistics provided by market analytics platforms.

However, there is another mechanism — soft liquidations — that occurs far more discreetly and often goes unnoticed by most market participants.

In practice, soft liquidations occur much more frequently than market statistics may suggest.

* Position liquidation is the forced full or partial closure of an open trading position by an exchange when the available collateral is no longer sufficient to cover current or potential losses. The purpose of this mechanism is to prevent a trader's account balance from becoming negative while reducing the exchange's credit risk.

* Leverage is a mechanism that allows a trader to open a position larger than their own capital by using borrowed funds provided by the exchange or other market participants. For example, 10× leverage enables a trader to open a $10,000 position with only $1,000 in collateral. The use of leverage proportionally increases both potential profits and potential losses.

What happens during a soft liquidation?

A traditional liquidation occurs when the price of a cryptocurrency reaches a level at which the trader's collateral is no longer sufficient to maintain the open position. The exchange then forcibly closes the position in full, a process typically accompanied by a sharp market move.

Soft liquidation follows a different approach. Rather than waiting until the trader's margin* is completely depleted, the exchange begins reducing the size of the position as soon as its risk level starts to increase, well before the critical liquidation threshold is reached.

* Margin refers to the trader's own funds posted as collateral when opening a leveraged position. The margin level determines the extent of losses that can be absorbed before the exchange is forced to intervene.

Instead of executing a single large market order that closes the entire position at once, the exchange carries out a series of smaller market orders. By distributing the volume over time, the additional pressure on the market becomes significantly less noticeable.

This approach is used by many major cryptocurrency exchanges. In their documentation, it is commonly referred to as partial position liquidation.

On some cryptocurrency exchanges, traders receive one or several margin call warnings before liquidation begins, indicating that the position is approaching a critical risk level. At this stage, the trader can still add more collateral, reduce the size of the position, or close it voluntarily without the exchange's intervention. If no action is taken, the platform initiates either partial or full liquidation in accordance with its internal risk management rules.

As a result of a soft liquidation, a trader may ultimately lose the entire position, yet the market will not experience the single large price impulse that typically accompanies conventional liquidations.

It is important to note that soft liquidation mechanisms are not implemented uniformly across all cryptocurrency exchanges. The portion of the position to be reduced, the maintenance margin requirements, and the liquidation sequence are determined by each exchange's internal policies. Consequently, two identical positions held on different exchanges may be liquidated in completely different ways.

It is also important to understand that a soft liquidation does not necessarily result in the complete closure of a position. On many cryptocurrency exchanges, the system first reduces the position to a level that corresponds to a lower maintenance margin requirement. If the remaining position once again becomes sufficiently collateralized following this reduction, the trader may continue to hold it without undergoing full liquidation.

This is why two traders using the same level of leverage can experience completely different outcomes: one may lose the entire position, while the other loses only part of it.

Why soft liquidations rarely appear in market statistics

Most analytics platforms primarily track forced liquidations, in which a position is closed due to insufficient margin.

Soft liquidations are different. From the system's perspective, they appear as a series of ordinary market transactions, which means these operations are often not identified or reported separately.

As a result, a significant gap can emerge between published liquidation statistics and the market's actual condition. Public data may suggest that very few liquidations have occurred, even though leveraged positions are already being reduced on a large scale.

This phenomenon is particularly noticeable during periods of sideways market movement*. Prices remain within a relatively narrow range, with no clear trend, while open interest gradually declines.

* Sideways movement (also known as a range-bound market or consolidation) is a market condition in which an asset's price fluctuates within a defined range between support and resistance levels for an extended period without forming a sustained uptrend or downtrend.

According to Glassnode, such periods are frequently accompanied by a decline in open interest without a significant increase in recorded liquidations. This suggests that the market is gradually unwinding leveraged positions, even though the usual signs of mass liquidations are absent.

How soft liquidations affect prices

Unlike traditional liquidations, soft liquidations rarely trigger sharp price movements. Instead of a single large liquidation event, they generate numerous smaller trades executed over an extended period.

One of the key advantages of soft liquidations is their ability to reduce slippage*. Executing a sequence of smaller orders generally has less impact on the order book than buying or selling a large position all at once, allowing the average execution price to remain closer to the prevailing market price.

* Slippage is the difference between the expected execution price of a trade and the actual price at which it is executed. Slippage occurs due to insufficient market liquidity or rapid price movements during order execution. Generally, the larger a trade is relative to the available liquidity in the order book, the greater the potential slippage.

As a result of soft liquidations, a cryptocurrency's price may remain within a narrow trading range for an extended period or even appear almost motionless.

Such periods are often perceived as times of market calm. In reality, however, leveraged positions are being steadily reduced beneath the surface.

Once a substantial portion of leveraged capital has already exited the market, it takes considerably less trading volume to trigger the next significant price move. This is why powerful breakouts frequently occur after prolonged periods of consolidation.

Why exchanges use soft liquidations

The primary purpose of soft liquidations is to reduce the risk of sharp price crashes and cascading liquidations*.

* Cascading liquidations are a chain reaction of forced position closures triggered by a sharp price movement. The liquidation of large positions increases buying or selling pressure, pushing the price further and triggering additional liquidations. This feedback loop can significantly amplify market volatility and lead to rapid price movements within a short period.

Closing a large position with a single market order can create substantial pressure on the market price, potentially triggering the liquidation of other traders. This, in turn, sets off a chain reaction that further increases market volatility.

Gradually reducing a position allows trading volume to be distributed over time, significantly reducing the market impact.

Soft liquidation mechanisms also benefit exchanges themselves. During periods of heightened volatility, it is not always possible to liquidate a position at its estimated liquidation price. If the proceeds from liquidation are insufficient to cover the trader's losses, the exchange must compensate for the shortfall using its insurance fund.

According to Binance, the use of soft liquidations helps reduce pressure on the insurance fund while lowering the likelihood of cascading liquidation events.

How to account for soft liquidations in market analysis

Although soft liquidations are not reported as a separate market metric, their presence can still be identified.

The primary indicator is Open Interest (OI)*. If the price remains within a relatively narrow range while open interest gradually declines, this may indicate that leveraged positions are being reduced over time.

* Open Interest (OI) is the total number of outstanding futures or perpetual contracts that remain open at a given point in time and have not yet been closed, settled, or offset. It reflects the amount of capital currently committed to the derivatives market. Rising open interest generally indicates fresh capital entering the market and increasing trading activity, while declining open interest suggests that positions are being closed and the overall amount of leveraged capital is shrinking.

Such data are available through analytics platforms such as Coinglass and Glassnode, as well as other specialized market intelligence services.

If the market appears calm while open interest continues to decline, this does not necessarily indicate a lack of activity. On the contrary, it may suggest that market participants are gradually reducing leveraged positions without generating significant price movements.

At the same time, a decline in open interest alone is not sufficient evidence of soft liquidations. The same pattern can result from traders voluntarily closing their positions. For this reason, analysts typically evaluate open interest alongside trading volume, funding rates, and price action. Only by considering these indicators together is it possible to distinguish between routine profit-taking and a market undergoing soft liquidations.

Another useful analytical tool is the Liquidation Heatmap, which highlights price levels where large concentrations of potential liquidations are expected. However, these heatmaps are predictive models that display estimated liquidation zones rather than liquidations that have actually taken place.

Conclusion

Soft liquidations rarely attract attention and are barely reflected in conventional market statistics. Nevertheless, they can significantly reshape market structure.

The gradual reduction of leveraged positions occurs without sharp price swings, reduces the overall level of leverage in the market, and creates conditions for the next major price movement.

For this reason, the absence of large liquidation events in analytics reports should not automatically be interpreted as a sign of a quiet market. Much of the deleveraging process may occur beneath the surface, and understanding how soft liquidations work allows market participants to assess market conditions more accurately and interpret market data with greater confidence.