Flash loans are one of DeFi’s most innovative yet controversial features shaking up the world of crypto. They are fast becoming popular with many consumers. However, before you go take one out do your research and read our informative guide that tells you everything you need to know about flash loans.
Flash Loan – A New and Unique Type of Loan!
Simply put a ‘flash loan’ is a new type of unsecured loan requiring no collateral, credit checks, amount limit, etc. Instead, the borrower must immediately repay the loan before the transaction ends. Capital is borrowed and repaid all in the one transaction. It all happens in a flash – hence the name. Many people see them as loans on steroids for the DeFi generation. These loans do have their origin in the Ethereum DeFi world.
A Flash Loan at Work
To give you an example of how a flash loan would work just imagine you ask the lender to borrow $20,000 in Ethereum. They approve and you repay the loan in the same transaction. The transaction is made up of three parts: receiving of the loan, doing something with the loan, and repayment of the loan. All these parts occur in an instant in the same block. This is one of the new innovations blockchain provides, and as blockchain technologies further evolve there will continue to be innovations that make loans easier and faster.
Repaying a Flash Loan
If you can’t repay a flash loan then you simply won’t be able to get it in the first place. It’s very black and white. A flash loan happens within a single transaction and so both parties (lender and the borrower) need to abide by the rules. If they can’t, then the loan won’t be issued. Smart contracts are on top of it. They won’t allow money to move unless the right conditions are met.
When to Use a Flash Loan
We wouldn’t recommend using these loans or any loans for that matter unless you have a good reason. The following are all reasons why some users of crypto would take out a flash loan.
Arbitrage
This is one of the most common uses of a flash loan as it has big potential for profit. Traders can make money by looking for price disparities across a number of different exchanges. For instance, two exchanges are pricing pizzacoin differently. You can use a flash loan to buy 100 pizzacoins for $ 50 at Exchange A, then sell them for $100 at Exchange B. The borrower then repays the loan and makes money from the difference.
Collateral Swap
This has less potential for profit but is a useful tool for users borrowing and lending crypto. A DeFi user can swap collateral that is used to obtain a loan from a lending app that use multiple crypto assets as collateral.
Self Liquidation
This is a type of short – or intermediate-term credit protocol which is repaid from money generated by the assets it is used to purchase. It’s a popular and reliable choice when purchases need to be financed quickly.
How Secure are Flash Loans?
As the technology is still fairly new and evolving it still presents problems and so in recent times flash loans have been the subject of several attacks. Known as ‘flash attacks’ they have unfortunately led to the loss of millions of dollars. However, this is normally an attack on a platform rather than a fault of flash loan technology. Flash Loans are as secure as the smart contracts that underwrite them. Different protocols will have their own smart contracts, so it is always advisable to do due diligence before using flash loans.
In a Flash
Excuse the pun here but we thought you would enjoy it! Hopefully, you have a much better understanding of flash loans and would only consider using them after you’ve done your proper research. Stay tuned for more innovations and news regarding flash loans and the world of crypto.