> For the complete documentation index, see [llms.txt](https://docs.opaldex.com/llms.txt). Markdown versions of documentation pages are available by appending `.md` to page URLs; this page is available as [Markdown](https://docs.opaldex.com/risk-engine/liquidation-mechanism.md).

# Liquidation Mechanism

#### Partial Liquidation First

When a position breaches maintenance margin:

**Step 1: Partial Reduction**

* Position is reduced proportionally
* Goal: Restore account to safe margin levels
* Minimizes capital loss for trader
* Prevents unnecessary full liquidations

**Step 2: Full Liquidation (If Needed)** Only if partial liquidation insufficient:

* Entire position closed
* Liquidation penalty applied
* Insurance fund covers any shortfall

**Liquidation Penalty** Calibrated to:

* Prevent predatory liquidations
* Discourage excessive leverage
* Ensure liquidators have incentive
* Maintain system health

***

### Insurance & Backstop Mechanisms

**Insurance Fund**

* Protocol-owned reserve funded by liquidation penalties
* Covers losses when liquidations occur below maintenance margin
* Transparent balance published on-chain

**Backstop Auction** In extreme scenarios where insurance is insufficient:

1. Position auctioned to liquidators
2. Dutch auction format (price decreases over time)
3. Ensures orderly liquidation even in illiquid conditions
4. Protects against cascading failures

**Social Loss Distribution** Last resort if all backstops exhausted:

* Losses distributed proportionally across profitable traders
* Transparent and verifiable process
* Historical precedent from successful exchanges

***

### Liquidation Example

**Scenario**: Trader has 10 ETH-PERP long at $3,000 (30,000 USD position)

* Initial margin: 10% ($3,000)
* Maintenance margin: 5% ($1,500)
* Current collateral: $2,000

**ETH drops to $2,900**:

* Position value: $29,000
* Margin requirement: $1,450 (still safe ✅)

**ETH drops to $2,800**:

* Position value: $28,000
* Margin requirement: $1,400
* **Liquidation triggered** ⚠️

**Partial Liquidation**:

* 5 ETH-PERP closed at $2,800 = $14,000 reduction
* Remaining position: 5 ETH-PERP long
* New position value: $14,000
* Margin requirement: $700
* Current collateral: $2,000 - loss
* **Account restored to health** ✅


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