What Is a ‘Liquidation Penalty’ and Its Purpose?
A liquidation penalty is a fee automatically applied to a collateralized debt position (Vault) when it is liquidated for falling below the minimum collateralization ratio. The purpose of the penalty is twofold: first, to deter users from letting their positions become under-collateralized, encouraging proactive risk management.
Second, the penalty revenue is often used to cover the costs of the liquidation process and provide a profit incentive for 'Keepers' (liquidators) to participate, ensuring the system remains solvent.
Glossar
Collateralized Debt Position
Mechanism ⎊ Collateralized Debt Positions represent a core component within decentralized finance, functioning as loans secured by cryptocurrency assets; these positions enable users to borrow assets against their crypto holdings, creating a dynamic interplay between lending and borrowing protocols.
Liquidation Penalty
Imposition ⎊ The penalty is a fee or discount applied to the proceeds of a forced sale of collateral during liquidation, designed to compensate the protocol or the liquidator for the operational cost and market disruption caused by the default.
Penalty
Consequence ⎊ A penalty within cryptocurrency, options trading, and financial derivatives typically represents a financial disincentive imposed for non-compliance with contract terms or exchange rules.