Clear DefinitionsLiquidation Penalty
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Pronunciation
[liq-wid-ay-shun pen-uhl-tee]
Analogy
Like an early withdrawal penalty on a CD that charges extra if you pull out funds before maturity.
Definition
An additional fee charged to a borrower when their collateralized position is liquidated for falling below maintenance requirements, intended to compensate protocol and incentivize health.
Key Points Intro
Liquidation penalties discourage risky leverage and fund the insurance pool.
Key Points
Penalty rate: Extra percentage (e.g., 5%) on collateral value.
Incentive: Funds go to liquidators or protocol reserve.
Trigger: Applied when health factor < 1.
Calculation: Based on collateral market value at liquidation time.
Example
Aave charges a 5% liquidation penalty on under‑collateralized positions, giving liquidators the collateral discount as reward.
Technical Deep Dive
On `liquidate()`, contract computes `seizeAmount = debt × (1 + penalty) / price`. Penalty portion sent to `liquidationReserve`, remainder to liquidator. Events track `LiquidationCall` with penalty fields.
Security Warning
Excessive penalties can deter liquidators and freeze markets; calibrate carefully.
Caveat
Penalty trade‑off: too low undermines deterrence; too high reduces participation.
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