It’s complicated. Liquidations are a last resort by the protocol to protect depositor funds. This job is especially important during sharp market downturns, and this is when things can become very volatile and uncertain.
For example, on-chain liquidity may suck during a market crash, in which case you need to compensate the liquidators to take the risk of bridging assets to other exchanges and hopefully get a better price. No lending protocol takes pleasure in having users be liquidated, but that’s the contract you agree to when you borrow funds.
Also, AAVE having control over the liquidations would mean that the system is not decentralized. It would be possible for AAVE to neglect its responsibility to protect the solvency of the protocol, and only depositors would suffer financially. Liquidations being open and well compensated lets depositors be confident that liquidators are properly incentivized to protect their funds. Any other known alternative simply provides weaker guarantees.
Liquidations are necessary, they are a mechanism to keep a protocol of in general finacial tools healthy.
And i don’t see the option that Aave liquidates your position and just gives you back what you lost due to the liquidation. Otherwise people have no consequences when they are a bad actor and don’t pay back anything or keep their HF low.
The bad actors used depegged stable tokens to borrow Harmony coins. Those depegged tokens although deppeged and not worth their full value, still have a value greater than 0, they need to be liquidated to compensate the Harmony lenders, even if the value isn’t 1:1 its better than nothing.
The deppeged collateral tokens can also alternativly be used to participate in the Harmony Recovery process. As the Harmony recovery process is buying them back over the next 3+ years to restore the peg.
However; they can’t be used for either option locked in their current state.
Not related to the Harmony use-case directly, but I have put up a proposal by B.Protocol to implement a Backstop for GHO on Aave, that in a way does let platform users benefit from the profitable liquidations, rather than just suffer from the bad liquidations. And of course stabilizing the GHO peg and other benefits as well.