Flash Loans

Borrow Instantly, Pay Back in One Block

Flash Loans Explained

Flash Loans allow for a DeFi user to borrow any amount of tokens from a liquidity pool without posting any collateral to obtain the loan. How is this possible? The main feature of a Flash Loan is that the loan must be returned to the liquidity pool within a single block transaction, effectively ensuring that the loan is funded. If the loan is not returned within one block transaction then the entire transaction is reversed and all actions are undone. The automatic loan reversal feature ensures that default risk and illiquidity risk are mitigated.

In short, a Flash Loan can be thought of as an unsecured loan that must be paid back within one transaction block otherwise it will fail to execute and the amount borrowed will be returned to the liquidity pool. Flash Loans can be accessed via “AAVE” or “dydx” platforms.

What to Know

In its current form, Flash Loans require extensive technical knowledge and were designed as a feature for developers to create smart contract-based loans. However, there are a few platforms that allow you to utilize flash loans without the need to “code” your own smart contracts. These platforms like Collateral Swap and Defi Saver have built a UI for non-technical participants to create flash loans.

Like most other things in DeFi, the rules are smart contract-based. If funds are not returned in a single block transaction, the loan will not execute to begin with. Specific parameters must be met – above all, the return of funds in the borrower’s instructions – for the loan to be approved.
Flash loans are unsecured loans in the traditional sense, ie; a borrower does not need to post collateral. Rather, flash loans are “secured” by the lender smart contract’s failure to execute unless the funds are returned within a single transaction.

Why it Matters

Flash loans are an interesting DeFi development, with no true analog in the traditional finance world. Flash loans are widely used by market participants to exploit arbitrage opportunities. For example, a flash loan borrower may be able to buy and sell the same token at a profit, within a single transaction, if the token is priced differently across two different trading venues. This enables a borrower to profit without having to risk any of his own capital. The long-term effect of flash loans may be the minimizing of arbitrage opportunities. Ultimately, this will lead to more liquid and orderly markets.  

Collateral can often have a stymieing effect on market participation. With flash loans, new participants can join a market and transact without having to put up capital.

Video by: Exodus Wallet

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