Flash Loans

Basic Idea:

Securing loans without putting up any collateral to initiate quick-fire trades. These loans, as their name suggests, take place over a very short time frame - valid within one transaction and must be repaid by the end of that transaction. A lender offering a flash loan bears no risk that the borrower defaults on its debt. Because a transaction and its instructions must be executed atomically, a flash loan is not granted if the transaction fails due to a debt default. This means no collateral is needed to be put up by the borrower as the lender is guaranteed.

 

People are able to use this to borrow crypto on platforms such as Bzx or DyDx and then end up using that for various activities on platforms such as Decentralised Exchanges (DEX’s). These pay-outs usually come from two stablecoins; DAI and USDC. Then, the borrower must repay the loan plus interest within the given time frame. Interest varies across platforms; Aave charges 0.09%, while DyDx only demands the repayment plus 1 Wei (the smallest denomination of ETH) in fees.

 

The assets for the flash loan are taken from a publicly funded smart contract pool.

 

Flash Loan Use Cases:

These types of loans can open up DeFi in many ways; arbitrage opportunities across platforms, trading, borrowing & lending, collateral swapping and flash minting to name a few.

 

  • Arbitrage: one can use the flash loan to make an arbitrage trade on an AMM DEX such as Uniswap. For example, a past user borrowed DAI from Aave, converted it into SAI on MakerDao, and then into ETH on Uniswap. This ETH was then immediately converted into DAI on Uniswap. If the market price or exchange rate on any of those tokens changes across time/platforms there is potential for arbitrage profit (or loss).

  • A flash mint function can be integrated into an ERC20 token, to mint an arbitrary number of coins within a transaction only. Before the transaction terminates, the minted coins will be burned. If the available amount of coins to be burned by the end of the transaction is less than those that were minted, the transaction is reverted (i.e. not executed).

 

Risks:
This is a relatively new concept in the DeFi ecosystem, and ‘black swan’ events could end up liquidating large quantities of counter-parties. Gas fees for transactions also tend to be much higher than for regular Ether transactions. Finally, the arbitrage opportunities leave the entire ecosystem vulnerable to attacks

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