That is true, but it is still an acceptable action within that context.

Paladins, at least the generic form of the term, aren't held to an impossible standard. If you pick specific versions of paladin, you might run into cases where an unintentional violation of oath works to negate their holiness, but that's rule issues, not concept issues.

Self defense is allowed within every version of paladin because they're knights, warriors. Illusion, insanity, trickery, it doesn't matter because that's external the the paladin. If their actions are righteous (and self defense is in this kind of discussion), and their intent was pure, they're still holy.

They might need to atone for the killing anyway, but that's a separate issue from them being a paladin.

If anything, Don Quixote's later actions show that he wouldn't have taken a life in his right mind, which points back to his righteousness.