Liquidation Incentives

Liquidation incentives are rewards provided to third-party participants, known as liquidators, for identifying and closing under-collateralized positions. When a user's account falls below the required margin, liquidators can step in to pay off the debt in exchange for the user's collateral at a discounted price.

This process is vital for the health of the protocol, as it ensures that bad debt is removed from the system and that lenders are protected. The incentive must be large enough to attract liquidators even during periods of high gas costs or network congestion, but not so large that it creates perverse incentives for market manipulation.

Balancing this reward is a key design parameter.