Liquidation Incentive Mechanisms

Liquidation Incentive Mechanisms are the economic structures designed to encourage third-party liquidators to close undercollateralized positions promptly. These mechanisms typically offer a bonus, paid from the liquidated user's collateral, to the entity that executes the liquidation transaction.

The size of this incentive must be carefully balanced; it must be high enough to cover gas costs and provide profit during high volatility, but low enough to avoid excessive losses for the liquidated user. Effective design ensures that liquidators remain active even when gas fees are high or market conditions are difficult.

This creates a competitive market for liquidation services, which is crucial for the rapid removal of toxic debt from the protocol. Well-calibrated incentives are the primary driver of protocol health during market downturns.