Liquidation Bonus Structures

Liquidation bonus structures are the financial incentives offered to liquidators for identifying and closing under-collateralized positions. When a position falls below the required collateralization ratio, a liquidator can pay off the debt in exchange for a portion of the collateral at a discount.

This bonus is intended to compensate the liquidator for the risk and effort involved, and it ensures that the protocol remains solvent by quickly removing bad debt. The size of the bonus is a critical design choice; it must be large enough to attract liquidators even during market volatility but not so large that it incentivizes malicious behavior.

If the bonus is too small, liquidations may not occur in time, leading to systemic risk. If it is too large, it can encourage attackers to manipulate prices to force liquidations.

Balancing this incentive is key to the robustness of lending protocols.