Liquidation Penalty Rate

The liquidation penalty rate is the additional fee charged to a borrower when their position is liquidated, serving as a deterrent against over-leveraging. This fee is typically paid by the borrower and distributed to the liquidators and sometimes the protocol's insurance fund.

A higher penalty rate discourages users from reaching the point of liquidation but also increases the total loss for the user when it occurs. The rate must be calibrated to ensure that liquidators are sufficiently compensated for their effort while keeping the liquidation process fair for the user.

If the penalty is too low, liquidators might ignore the position, leading to bad debt. If it is too high, it creates an overly punitive environment that may drive users away from the protocol.