Introduction to Spot and Contract Concepts

Cryptocurrency investors often use two main trading methods: spot trading and contract trading. To better grasp the concept of “negative balance,” it’s essential first to understand these two trading approaches.

Spot Trading

Spot trading involves directly buying and selling cryptocurrencies at current market prices. Once purchased, investors own the asset, which can be stored in a personal wallet.

• Key Features:
  1.Ownership of Assets: Buyers gain full control of the tokens they purchase.
  2.No Leverage Involved: There’s no borrowing, so risks are relatively low.
  3.Profits Follow Market Movements: Returns depend on the asset’s price changes.

• Best Suited For: Investors who are risk-averse and prefer holding assets long-term.

Contract Trading

Contract trading, on the other hand, is a form of derivative trading where investors do not directly hold the asset. Instead, they trade contracts to predict market price movements. Contract trading allows the use of leverage, significantly increasing capital efficiency, but also multiplying risks.

• Key Features:

1. Leverage Available: Small investments can control large positions (e.g., 2x–100x leverage).
2. Dual Direction Trading: Enables both long positions (predicting price increases) and short positions (predicting price decreases).
3. Flexible Settlement: Can be physical delivery (actual asset ownership) or cash settlement (only the profit and loss difference is settled).

• Best Suited For: Investors who are comfortable with high-risk scenarios and have experience in short-term trading.

In addition, perpetual futures contracts are one of the most common types of contracts in cryptocurrency. This derivative trading method enables users to go long (betting on price increases) or short (betting on price decreases) for arbitrage purposes. As noted above, contracts allow for leverage, giving investors the potential to earn returns several times their initial capital.

Perpetual contracts are also highly flexible since positions don’t need to be settled on a specific date. Traders can open and close positions at any time based on market movements.

Example: BTC/USDT Perpetual Contract Interface on Gate.io (Source：https://www.gate.io/zh-tw/futures/USDT/BTC_USDT)

Key Terms in Contract Trading Explained

Leverage

Leverage is a key feature of contract trading, allowing investors to control larger positions with less capital. While higher leverage can amplify profits, it also increases risk. In simple terms, high leverage brings both high potential gains and high risks, while low leverage offers more modest gains and lower risks.

• Example:
  • Imagine trading with “100 USD and 10x leverage.” The actual position controlled is 100 USD × 10 = 1,000 USD.
  • If the asset price rises by 1%, you earn 1,000 USD × 1% = 10 USD, i.e., a 10% return.
  • If the price falls by 1%, you lose 10% of your initial capital.

Illustration: BTC/USDT Gate.io Perpetual Contract Leverage Selection (Source：https://www.gate.io/zh-tw/futures/USDT/BTC_USDT)

Open & Close Position

• Open Position: Starting a trade by buying (long) or selling (short).
• Close Position: Ending the trade and calculating profits or losses.

Margin

Margin is the capital required to open a position, serving as a deposit for the trade.

• Initial Margin: The minimum deposit needed to start a position.
• Maintenance Margin: The minimum balance required to keep the position open. Falling below this level can trigger liquidation.
• Example:
  • If you use 10x leverage to purchase a 1,000 USD contract, the initial margin required is 1,000 ÷ 10 = 100 USD.
  • If the market declines, reducing the account balance below the maintenance margin (e.g., 50 USD), your position may be forcibly liquidated.

Margin Ratio

The margin ratio measures the risk of a position by comparing the margin balance to the position value. Falling below the platform’s minimum margin ratio may trigger liquidation.

• Formula: Margin Ratio = Margin ÷ Position Value × 100%.
• Example:
  • If the position value is 1,000 USD and the margin balance is 50 USD: Margin Ratio = 50 ÷ 1,000 × 100% = 5%.
  • If the platform’s minimum requirement is 10%, you must add more margin to avoid liquidation.

Long Position & Short Position

• Long Position
  • A long position refers to when an investor expects the price of an asset to rise. This occurs in situations like a bull market (upward market trend) or when the investor holds an optimistic view of the asset’s future price. The investor buys the asset (or contract), hoping to sell it later at a higher price to make a profit.
  • A long position is a type of position in contract trading that predicts the asset’s price will increase.
  • Purchase a contract → Asset price rises → Sell the contract at a higher price → Earn profit.
• Short Position
  • A short position refers to when an investor expects the price of an asset to fall. This usually occurs in a bear market (downward market trend) or when the investor has a pessimistic outlook on the asset’s future price. The investor sells the asset (or contract) first, intending to repurchase it later at a lower price and profit from the price difference.
  • A short position is a type of position in contract trading that predicts the asset’s price will decrease.
  • Sell a contract → Asset price falls → Buy the contract back at a lower price → Earn profit.

Liquidation

• When market price fluctuations cause the account balance to fall below the maintenance margin, the platform automatically closes positions to prevent further losses. This is also referred to as liquidation.

Long Liquidation

• A long position predicts a future market rise. Simply put, the investor borrows funds to buy a contract, sells it after the price increases to earn the price difference, and repays the borrowed funds, leaving the profit as the remaining amount.
• However, if the market falls, causing losses equal to the account’s margin, the system will trigger the negative balance mechanism. At this point, all the margin in the account will be deducted, resulting in a total loss of funds. This is called long liquidation.
• Example: If you believe the price will rise and open a 10x long position:
  • Assume your margin is 1,000 USDT. With 10x leverage, the exchange lends you 9,000 USDT, allowing you to open a position worth 10,000 USDT.
  • If the asset price drops by 10%, the position value will shrink by 1,000 USDT, which is equal to your margin. To avoid further losses, the exchange will forcibly reclaim the 9,000 USDT loan. Your account balance will become zero since the 10,000 USDT position has already incurred the loss. This is a case of long liquidation.

Short Liquidation

• A short position predicts a future market decline. Simply put, the investor borrows the asset to sell first and then repurchases it at a lower price, keeping the difference as profit.
• In contract trading, if the price rises slightly while shorting, causing the margin to fall short of fully repurchasing the borrowed assets but still above the minimum maintenance margin, the system will not trigger forced liquidation. Instead, the investor can continue holding the position, a situation called “carrying the position.”
• The triggering of “forced liquidation” depends on whether the account’s margin balance can cover the floating losses. The specific conditions are as follows:
  • Floating Losses Exceed Margin: When market price fluctuations cause losses exceeding the available margin, the system immediately triggers forced liquidation to prevent further losses.
  • Conditions for Holding a Position: The system will not force liquidation as long as the remaining margin (including both used and unused margin) meets the platform’s minimum maintenance margin requirement. Investors can choose to continue holding the position (carry the position) or close it voluntarily.

Visual Example: Liquidation Heatmap (Source: https://www.coinglass.com/zh-TW/LiquidationData)

Gate.io Forced Liquidation Process

Gate.io adopts the mark price mechanism to prevent forced liquidation caused by low liquidity or market manipulation. The effects of forced liquidation depend on the leverage mode used (isolated margin or full margin).

Isolated Margin Mode

In isolated margin mode, forced liquidation occurs when the margin balance for a specific position falls below the required maintenance margin. Each position operates independently with its own margin ratio, and liquidation decisions are made on a per-position basis.

Full Margin Mode

All positions share a common margin balance in full margin mode, and unrealized profits and losses are included in the total margin. Forced liquidation is triggered when the account’s margin ratio falls to 100% or below.

How Forced Liquidation Works

1. Trigger Condition: Forced liquidation begins when the account margin ratio falls to 100% or less.
2. Cancel Pending Orders: All unfilled pending orders are automatically canceled.
3. Stepwise Liquidation via Risk Limit Adjustment: The system reduces the risk limit for the position by one tier and liquidates any portion of the position exceeding the adjusted limit.
4. Check if Liquidation Should Stop: During this process, the system monitors if the margin ratio recovers to 100% or higher.
   1. If it recovers to 100% or higher: Liquidation stops.
   2. If it does not recover: The system continues lowering the risk limit and liquidating the position incrementally until either the margin ratio is restored or the position is entirely liquidated.

What is Negative Balance？

Negative balance is an extreme situation that occurs in leveraged trading (such as contract trading). It refers to a scenario where an investor’s losses not only exhaust all the margin in their account but also result in a negative balance, meaning the investor owes additional funds to the trading platform. Simply put, after a negative balance situation occurs, the investor loses all their initial capital and is in debt to the platform.

Negative balance typically arises due to sharp market volatility (rapid price increases or decreases) or insufficient liquidity, causing the liquidation mechanism to fail to act promptly. As a result, the borrowed funds (or assets) cannot be repaid, and the price gaps exceed the margin’s capacity.

In traditional futures markets, where volatility and leverage ratios are lower, there is still a negative balance risk under extreme conditions. However, in cryptocurrency trading markets, where price fluctuations are higher, and leverage ratios are greater, the risk of a negative balance is significantly increased.

For example, if an investor goes long on Bitcoin with a liquidation price of $95,000, there might be insufficient orders at the $95,000 level during intense market volatility. This causes the price to rapidly drop below $95,000. At this point, the investor’s contract is not liquidated, and the position cannot be settled at a price higher than the bankruptcy price, leading to losses that exceed the margin deposited by the investor.

Strategies to Prevent Negative Balance

• Control Leverage Reasonably:
  • Leverage amplifies profits but also magnifies losses. The higher the leverage, the greater the risk.
  • Excessively high leverage increases the likelihood of quickly depleting margin funds with small market movements, raising the risk of negative balance.
• Set Stop Losses:
  • Stop-loss prices should be set within the investor’s acceptable loss range.
  • Define a maximum acceptable loss amount to avoid relying on forced liquidation by the system, which can prevent greater losses.
• Manage Positions Properly:
  • Avoid using all your funds in a single position (full margin trading), as it exposes you to single-market risks. And allocate funds across trades wisely.
• Monitor Margin Ratio Constantly:
  • The margin ratio is a critical indicator of position stability; a low margin ratio can trigger forced liquidation.
  • Add margin when necessary to keep the margin ratio within a safe range.
  • Use “margin alerts” to receive notifications when margin approaches critical levels.

• Choose a Reliable Trading Platform:

  • High-liquidity trading platforms can execute forced liquidation more promptly, reducing the chance of negative balance.
  • Check if the platform provides negative balance protection (investors are not held responsible for negative balances) and if there is a risk reserve fund to cover negative balance losses.
  • For instance, Gate.io launched an updated isolated margin trading feature on January 6, 2025, which adopts a tiered maintenance margin ratio algorithm to enhance risk management. This upgrade provides smaller-scale users with better liquidation price levels, reducing the risk of negative balance. (Details: https://www.gate.io/zh-tw/announcements/article/42317)

  • Some exchanges employ a “negative balance sharing” model:

    • When sharp market fluctuations lead to negative balance events where some contract users cannot liquidate positions in time, causing losses beyond their margin, all profitable users must share the losses incurred by the negative balance users. \

  • Other exchanges utilize an insurance fund to address negative balance issues. Losses incurred by users are covered by the insurance fund, which is funded by the surplus from forced liquidation trades:

    • When a user’s assets are forcibly liquidated, the system places orders at the bankruptcy price and matches them in the market. If the actual transaction price is better than the bankruptcy price, the surplus funds are deposited into the insurance fund.
    • This mechanism, where the insurance fund covers negative balance losses, is known as “negative balance coverage.” However, if the insurance fund cannot fully cover the losses, the auto-deleveraging system (ADL) takes over the liquidated position. For example, CoinEx uses this mechanism, and users can check the details of their insurance fund on the platform.

Liquidation vs. Negative Balance

Conclusion

The cryptocurrency market, known for its high volatility and leverage potential, offers significant profit opportunities for investors but also comes with considerable risks. Negative balance situations occur due to drastic market swings, price gaps, or low liquidity, causing losses that exceed the initial margin and result in investors owing funds to exchanges. Such scenarios place a heavy burden on both traders and platforms.

Key takeaways from this analysis:

1. Different Risk Profiles of Spot and Contract Trading: Spot trading is more conservative and caters to long-term investors. In contrast, contract trading involves leverage, making it ideal for short-term traders with high-risk tolerance. However, the higher the leverage, the greater the risk, so careful selection and planning are essential.
2. The Importance of Risk Management: The key to avoiding negative balance lies in risk management, including setting stop-losses, controlling leverage multiples, managing positions, and continuously monitoring margin ratios. Proper risk control can significantly reduce the likelihood of liquidation and negative balance scenarios.
3. The Need for a Reliable Platform: High-liquidity platforms with robust risk control mechanisms can better support investors in navigating extreme market conditions. Additionally, it is important to consider whether a platform offers negative balance protection and how its insurance fund operates.

Investors can better protect themselves while pursuing returns by gaining a solid understanding of leverage trading fundamentals, mastering terms like margin, liquidation, and negative balance, and implementing sound risk management strategies. Staying informed about market trends and adhering to disciplined strategies are key to maintaining resilience and achieving success in this dynamic market.