What Are Flash Loans? Complete Guide
You might have heard about flash loans if you’re trading in cryptocurrency. Flash loans are established to buy & sell different types of cryptocurrency smoothly on an exchange for crypto traders.
Primarily, flash loans were introduced in 2018 on the DeFi and joined the Ethereum network in January 2020. Flash loans are very popular these days among investors.
Flash Loans Explained
In this article, I will tell you about flash loans in detail. Does this article have the answers to all your questions like how flash loans work? Is it safe? Pros & Cons? Flash loan attack? And many more relevant topics.
Read the full article for the complete guide on flash loans. So, without wasting time let’s get started.
What Is A Flash Loan?
A Flash loan is a digital loan accessible on a decentralized finance network, based on some protocols & secured by a blockchain network available for crypto investors & traders.
It is an uncollateralized loan provided by a lender to a borrower by utilizing a digitally facilitated agreement, written in code language on the blockchain technology (smart contract).
The Flash loans work between the two parties (lender & borrower) and it doesn’t involve third parties.
Flash loans arrived on the Ethereum network in January 2020 & began through Aave Flash Loans, a platform that runs as a decentralized non-custodial liquidity market protocol for depositors & borrowers.
Aave platform had already issued $4 billion approx in flash loans by June 2021.
Flash loans are advantageous in some ways as it provides the loan instantly to the borrower because it encapsulates the entire transaction with the ability to arbitrage, an investment strategy to buy & sell the same assets in different markets to get the advantage of different prices.
It means that if the trader doesn’t make a profit from the loan, the transactions get reversed & funds get returned to the lender, all this happens in a single transaction block.
How Do Flash Loans Work?
Flash loans use Aave protocols with a fee of 0.09% and a smart contract to provide the borrower a loan, if it makes a profit then the borrower needs to pay a fee to DeFi protocols and if it is unprofitable then the funds return to the lender or provider of the flash loan. BasItunds like an easy, low-low-risk to borrow funds in the crypto market.
Flash loans run on the smart contract on the DeFi network, it constructs a request that acts as a contract on a blockchain to borrow funds to earn profit.
The smart contract can be programmed by a developer as it requires writing code, although you can use several tools available online to simplify the smart contracts on the blockchain.
How Safe Are These Flash Loans?
As we have already known, flash loans work on smart contracts but are they protected from hackers?
Well, the answer to this question is quite familiar because smart contracts are not always written correctly and the data received is insecure or inaccurate so, it involves a risk of hacking.
There are already many attacks that have been recorded previously on flash loans which result in the loss of millions of dollars for the lenders.
Hackers never leave an opportunity to perform malicious activity on the DeFi network. However, most of the people in the crypto market believe that upgrading & enhancing the technology can prevent it from malicious activities as it is a unique technology.
Why Would I Want To Use A Flash Loan?
Flash loans help investors to gain profit without putting their own money at risk. It is a potential way to take advantage of instant loans with fewer resources. There are several factors responsible to use flash loan and they are as follow-
- Arbitrage: The most popular use of flash loans is arbitrage. Traders want to earn by spotting price discrepancies across several exchanges in different types of the crypto market. The trader can use flash loans and a separate smart contract to purchase an exchange at lower prices and subsequently sell them at different exchanges to generate revenue from higher prices.
- Low transaction fee: Due to flash loans, the number of transactions is combined in a single transaction to reduce the transaction fee.
Pros & Cons Of Flash Loans
The crypto market is known for volatility and it involves risk. Flash loans are the new technology specially built for traders to get profit from this rapid loan. Below are the summarized pros of the flash loan.
- Instant loan.
- Low transaction fee.
- Single transaction block.
- No collateral swap is required.
- Developing technology.
- Attackers can hack the system.
What If I Don’t Pay Back A Flash Loan?
The flash loan runs on the smart contract system. If the trader gets the profit from the flash loan then the lender will get its loan repaid and the transaction will be called complete.
However, if in any case, the flash loan trade doesn’t give the trader profit then the smart contract reverses the entire transaction and the flash loan will get back to the lender.
All this can be done with the help of smart contracts between lenders & traders. The lending mechanism of the smart contracts almost reduces the risk for the lender and reverses the whole transaction if the borrower doesn’t repay the loan to the lender.
What Is A Flash Loan Attack?
A flash loan attack is the manipulation of the smart contract security by the attacker during the loan borrowing.
An attacker usually borrows a lot of funds from different lenders in which collaterals are not required and then the attacker manipulates the price of the crypto asset on one exchange and instantly resells it on another one.
Technically, the process is quite complex and involves multiple accounts, high risk & so many steps to steal the funds.
Are Flash Loans Legal?
If we talk about the current scenario in terms of the crypto market then yes flash loans are legal.
Because the crypto market depends on the blockchain network and flash loans facilities the buying & selling for traders with the use of smart contracts.
But if we talk about the future, the crypto market will be more regulated & secure and we cannot predict anything now.
Flash Loans: Conclusion
Flash loans are popular among investors in the crypto market exchange. All thanks to the smart contract mechanism that makes the usage of the flash loans easy & covers the entire transaction in a single block with a comparatively low fee.
The crypto market is vast & volatile and to enter the cryptocurrencies world, you need to understand everything from the scratch.