Liquidator Incentive Design

Liquidator Incentive Design focuses on creating the economic structures that encourage independent actors to monitor and liquidate under-collateralized positions. Since liquidation is a critical function for system health, protocols must ensure that liquidators are rewarded sufficiently for their effort and risk.

This often involves offering a discount on the liquidated collateral, which allows the liquidator to capture the difference between the liquidation price and the market price. The design must be calibrated to ensure that liquidators remain active even during periods of high market stress when liquidations are most needed.

If the incentive is too low, liquidations may stall; if it is too high, it may unnecessarily penalize the user being liquidated.