What is the death penalty in this game?

Death below level 10 - no XP loss. Death afterwards (as far as I know) is 5% loss but I only got to level 50, so can't tell you after that.

PvP can only start after level 30 on all servers. On PvE server you choose you enter PvP mode (at least 10 hours) and on PvP server you are vulnerable after level 30. There is no XP loss from PK, but items can be lost if your name is Pink or Red. Your name becomes Pink when you attack another player and darkens to Red the more you attack.

There's a (very small) risk of dropping an item on death (usually around 1%) even if you are not Pink- or Red- named. Being pink- or red-named increases that risk drastically. Binding items to you, or carrying Guardian Angels, negates that risk. The XP loss starts at 5% at level 10 but decreases as you go up in level (although it takes as many or more kills to get the XP back).

If there is an item to protect from item loss -- the Guardian Angel as gattsuru stated -- then those pink and red PKers can PK all they want without running the risk of loosing gear when they get killed.

At usual Death you loose:

LvL 10-19 5% Exp. without any Cultivation Level
LvL 19-29 4.5% Exp. with Culti LvL 19
LvL 29-39 4% Exp. with Culti LvL 29
LvL 39-49 3.5% Exp. with Culti LvL 39
LvL 49-59 3% Exp. with Culti LvL 49
LvL 59-69 2.5% Exp. with Culti LvL 59
LvL 69-79 2% Exp. with Culti LvL 69
LvL 79-89 1% Exp. with Culti LvL 79
LvL 89-99 0.6 % Exp. with Culti LvL 89
LvL 99-105 0.4 % Exp. with Culti LvL 99

as far as i understand it, it just reduces the risk of dropping. so for people who don't pk that risk is already low... but nasty reds still suffer drops coz they have already got a high risk.

No, it totally negates the risk entirely. If you have a guardian scroll you neither lose XP nor drop items ever. That said, guardian scrolls vanish after you die, so you'd need to keep restocking to take advantage of this.

If there is an item to protect from item loss -- the Guardian Angel as gattsuru stated -- then those pink and red PKers can PK all they want without running the risk of loosing gear when they get killed.

Actually its worse than that. PK'ers don't need Guardian Angels (scrolls) to PK as much as they like. Not as long as we have Safety Lock.

Safety Lock was originally designed to prevent people from logging into YOUR account and dropping all your stuff or trading it over to another character. Unfortunately, this means that no items can be dropped or traded or bought while Safety Lock is on. This also applies in PvP, however, meaning that no matter how often you are PK'd you will never drop equipment or items.

Instead, to balance it out they gave a very small chance of equipment shatter and you'll drop some of the mirage celestones you'll require to get the weapon repaired. The amount of mirages required differes between weapons.

It's unfortunate, but it means there is no real downside to being a rednamed player. The in-built 'punishment' system for battling non-combatants and lowbies goes to waste the instant the PK'ers put Safety Lock on. The chance of equipment shatter is also extremely low compared to the chance of dropping items with SL off. Deep reds are almost certain to drop gear and items, but with SL on theres only a 4% chance of equipment to shatter.

It's something the devs really need to address if they want to balance the PvP aspect of the game.