What Is a ‘Liquidation Penalty’ in Decentralized Derivatives?

A liquidation penalty is a fee charged to a leveraged position that is being automatically closed (liquidated) because its collateral has fallen below the maintenance margin. This penalty is typically a percentage of the remaining collateral and is often paid to the liquidator who executed the closing transaction.

The penalty incentivizes liquidators to quickly close risky positions, ensuring the protocol remains solvent and preventing bad debt.