Liquidation Penalty
An additional cost charged to a borrower whose position is liquidated, on top of losing the collateral needed to cover the outstanding debt.
A liquidation penalty is an additional cost charged to a borrower whose position is liquidated (see Kaavon's "Liquidation" glossary definition) — on top of losing the collateral needed to cover their outstanding debt, the borrower typically forfeits an extra percentage as a penalty, which is generally used to compensate whoever performs the liquidation and to help cover the protocol's risk.
The existence of a liquidation penalty is a concrete, real cost that makes avoiding liquidation in the first place — by maintaining a healthy collateralization ratio — meaningfully better than simply letting a position get liquidated and reclaiming only the remainder.
Examples
- A borrower facing liquidation loses not just enough collateral to cover their debt, but an additional liquidation penalty on top of it.
- A liquidation penalty gives a borrower a direct financial incentive to proactively manage their position's collateralization ratio rather than letting it drift toward liquidation.