Margin Requirement

The initial margin is the minimum collateral a trader must post to open a new leveraged position. It is calculated as a percentage of the total position's notional value. For example, a 10x leverage trade on a $10,000 position requires a $1,000 initial margin. This acts as a security deposit against initial price fluctuations.

The maintenance margin is the minimum collateral required to keep an open position from being liquidated. It is typically lower than the initial margin. If the account's equity (total value minus borrowed funds) falls below this threshold, the trader receives a margin call and must add funds or face automatic liquidation.

A margin call is an alert that an account's equity has fallen below the maintenance margin requirement. The trader must deposit more collateral (variation margin) to restore the required level. Failure to do so triggers liquidation, where the protocol automatically closes the position to repay lenders, often via a liquidation auction or keeper network.

These are two primary account modes for managing risk:

• Isolated Margin: Collateral is allocated to a single position. Losses are capped to that specific deposit, protecting other assets.
• Cross Margin: All account balance is used as shared collateral for all open positions. This allows for greater capital efficiency but increases risk, as a loss in one trade can affect others.

The liquidation price is the specific market price at which a position's equity equals the maintenance margin requirement, triggering a margin call or liquidation. It is dynamically calculated based on the entry price, leverage, collateral amount, and fees. Traders monitor this price closely to manage risk.

Protocols dynamically adjust margin requirements based on risk parameters like:

• Asset Volatility: More volatile assets require higher margins.
• Liquidity Depth: Less liquid markets may have stricter requirements.
• Protocol Utilization: High borrowing demand can trigger increases. These parameters are often managed by governance or automated risk engines to maintain system solvency.

Two distinct requirements govern a leveraged position. Initial Margin is the collateral required to open a position. Maintenance Margin is the minimum collateral that must be held to keep the position open. If the account's equity falls below this level, it triggers a margin call or liquidation.

When the value of a position moves against the trader, their equity (collateral minus losses) decreases. If it falls below the maintenance margin requirement, the protocol will automatically liquidate the position. This process sells the collateral to repay the borrowed funds, protecting the lender but resulting in a total loss of the trader's initial margin.

The liquidation price is the market price at which a position will be liquidated. It is determined by the formula:

• Long Position: Liquidation Price = Entry Price * (1 - Initial Margin Ratio) / (1 - Maintenance Margin Ratio)
• Short Position: Liquidation Price = Entry Price * (1 + Initial Margin Ratio) / (1 + Maintenance Margin Ratio) Understanding this is critical for risk management.

Using high leverage (e.g., 10x or 100x) dramatically amplifies risk. A small adverse price movement can quickly erase the margin buffer and trigger liquidation. This is a primary cause of loss for retail traders, as positions can be liquidated before the market has a chance to recover.

Margin requirements are not universal. Each DeFi lending or perpetuals protocol (e.g., Aave, Compound, dYdX) sets its own parameters. Key variables include:

• Loan-to-Value (LTV) Ratio: The maximum borrowing power against collateral.
• Liquidation Threshold: The LTV level that triggers liquidation.
• Liquidation Penalty: An additional fee charged during liquidation.

In volatile markets, mass liquidations can create cascading effects. As large positions are liquidated, they create sell pressure, pushing the market price down further and triggering more liquidations. This can lead to funding rate volatility, extreme price slippage, and temporary insolvency for protocols if liquidators cannot keep up.

The initial margin is the minimum amount of collateral a trader must deposit to open a leveraged position. It is expressed as a percentage of the total position value.

• Purpose: Acts as a security deposit to cover potential initial losses.
• Example: A 10% initial margin requirement means a trader must post $10,000 in collateral to control a $100,000 position.

The maintenance margin is the minimum amount of equity a trader must maintain in their account after opening a position to avoid a margin call or liquidation.

• Function: A risk management buffer that protects lenders and protocols.
• Trigger: If the account's equity falls below this level, the position is at risk of being automatically closed.

A margin call is a broker's or protocol's demand for a trader to deposit additional funds or collateral when their account equity falls below the maintenance margin requirement.

• Mechanism: It is a warning before forced liquidation.
• In DeFi: Often automated; if the call is not met, the position is liquidated to repay lenders.

Liquidation is the forced closure of a trader's leveraged position when their collateral value falls below the protocol's required threshold (the liquidation margin).

• Process: The protocol sells the collateral to repay the borrowed funds, often at a discount.
• Result: The trader loses their remaining collateral, minus a liquidation penalty paid to the liquidator.

The leverage ratio measures the degree of borrowed funds used in a position relative to the trader's own capital (collateral).

• Calculation: Total Position Value / Collateral Value.
• Inverse of Margin: A 10% initial margin requirement equates to 10x leverage.
• Risk: Higher leverage amplifies both potential gains and losses.

In DeFi lending protocols, the collateral factor (or loan-to-value ratio, LTV) determines the maximum amount a user can borrow against their deposited collateral.

• Direct Relation: It defines the initial margin requirement for borrowing. A 75% LTV means a user must maintain at least 25% equity (collateral) against the loan.
• Key Parameter: Set by governance and varies by asset based on perceived risk and volatility.