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.