What are Flash Loans?

What are Flash Loans?

Instant loans or flash loans (from the English. Flash Loans) is a function in a number of popular DeFi-protocols that allows you to borrow cryptocurrency assets without collateral, with the condition that the debt will be returned in the same block of transactions.

Flash loans have become one of the most significant events in the world of decentralized finance in 2020, bringing profit to some market participants and losses to others.

How and when did Flash Loans appear?

Since the beginning of the development of decentralized lending, all loans in cryptoassets required the borrower to provide excess collateral (collateral). That changed in January 2020 when UK-based lending company Aave launched a decentralized lending protocol based on liquidity pools. Instant Unsecured Loans have been made available to third party DeFi developers.

The basic requirement for a flash loan is simple: transactions for obtaining and repaying a loan, as well as any intermediate transactions with issued funds, must occur within one block of transactions. For this reason, it takes only a few seconds from borrowing to paying off the loan. At the same time, the size of an instant loan can reach tens of millions of dollars, and the commission for its issuance is only 0.09% of the amount (in addition to the cost of gas for accessing smart contracts).

DeFi application developers appreciated the huge potential of instant borrowing almost immediately after opening Aave’s documentation for this feature. However, they became really in demand after a few months, with a manifold increase in the number of users of DeFi services and a subsequent increase in commissions on the Ethereum network. Conventional DeFi transactions were too expensive, and the use of instant borrowing strategies significantly reduced transaction costs and found new opportunities to generate profits.

At the end of 2020, the Aave landing platform processed $ 2 billion in flash loans, and by the end of the first half of 2021, this amount had grown to $ 4.2 billion. According to the service AaveWatchThe largest instant loan was $ 195 million.

In the first half of 2020, the flash credits feature became available to users of the dYdX decentralized trading platform. An analogue of instant loans can be considered the function of flash swaps, which was offered in May 2021 by the popular decentralized crypto exchange Uniswap in the version of the protocol v2.

Users were able to lend without collateral for more than 100 tokens that can be used for arbitrage transactions (for example, between Uniswap and SushiSwap) and other strategies. This function can only be accessed through smart contracts, as there is no user interface. The loan cost is 0.3% (excluding gas fees and Uniswap fees).

When to use instant loans?

The opportunity to obtain cheap unsecured loans has opened up many opportunities for users of DeFi services, both to profit from market inefficiencies and to reduce the cost of lending and other operations. Below are the most common use cases for Flash Credits.

Arbitration trade

Making a profit from the exchange rate difference of one asset on different trading floors implies the use of a large amount of your own funds. Instant loans become a source of cheap financing for such operations according to the following scheme:

• take a flash loan for this asset from the DeFi protocol;
• use borrowed funds to buy an asset on the DEX where it is cheaper;
• sell an asset on the DEX where it is more expensive;
• return flash loan with commissions and interest.

It is arbitrage trading that is considered the most popular use case for flash credits.

Self-liquidation of debt positions

When the value of the collateral falls below the value of the borrower’s debt, the lending protocols trigger an automatic liquidation procedure. Part of the collateral is sold to pay off the debt, while a liquidation penalty is charged, which, for example, on Aave is 5% or 10% (depending on the type of collateral), and in the case of Vaults of the MakerDAO service – 13%.

The use of instant loans allows, without waiting for this expensive procedure, to carry out a much cheaper self-liquidation without fines according to the following scheme:

• take a flash loan for this asset;
• repay the debt with borrowed funds and thereby release the security deposit;
• to use part of the security deposit to pay off the flash loan with the corresponding commissions and interest.

Quick replacement of collateral

Replacement of loan collateral may be required, for example, when the price of the collateral asset falls, when the risk of liquidation increases. In this case, it is reasonable to replace the falling asset with a growing or less volatile crypto asset.

Conventional collateral replacement requires full debt repayment and then reopening, which increases transaction fees and requires full debt. Flash loans allow you to do this much faster and cheaper by combining all transactions in one block.

Fast refinancing of loans

Lending rates on various DeFi platforms are constantly changing depending on market conditions and available liquidity. Flash loans have proven to be a convenient tool for cheap “transfer” of credit to platforms with lower rates, including the exchange of collateral for another asset.

How to use instant loans?

Initially, the instant loans feature was open only to developers. There was no public user interface, and access to this function was only possible through smart contracts. However, in 2020, third-party services appeared that provided access to Flash credits to users who did not own Solidity.

CollateralSwap

This service with the most simple interface can only work with the MakerDAO service so far, performing two tasks:

• quick replacement of collateral without having to pay off outstanding debt (for example, replace ETH with USDC);
• self-liquidation of a debt position without fines.

In both cases, the CollateralSwap fee is 0.29%.

DeFi Saver

It is a DeFi application that works with the MakerDAO, Aave, Compound, dYdX and Reflexer protocols and gives users the flexibility to manage assets and loans. The Recipe Creator option makes it easy to create your own strategies using Aave and dYdX Flash Credits.

Furucombo

This is an application that allows you to create your own DeFi strategies, called “combos”, using visual programming. Each transaction in a “combo” is displayed as a cube. The user can customize the parameters of the cubes and their order. Then the service combines all the cubes into one transaction and sends them for execution. Aave Flash Credits are the basis for many of the boilerplate “combos” available in this app.

Are there flash loans in alternative ecosystems?

With the growing popularity of EVM-compatible blockchain platforms (Binance Smart Chain, Solana, Avalanche, Polygon, Fantom) in the first half of 2021, the flash credit function became available to users of these networks.

In April 2021, the Aave protocol was deployed on the Polygon network. Since then, users have been able to use instant unsecured loans in the same way as before on the Ethereum network with the same 0.09% commission. Of course, with the difference that all transactions in the Polygon network cost thousandths of a cent…

At the same time, in April 2021, the CREAM Finance project offered its version of flash credits on the Binance Smart Chain. Later, this feature became available on the Polygon and Fantom networks. At the same time, the commission of the CREAM protocol is only 0.03%.

Other flash lending platforms on the Polygon network include UniLend Finance. An unsecured borrowing of the MATIC token is available for users with a commission of 0.05%.

On the Solana network, the Solaris Protocol landing platform is about to offer Flash Credits. As of summer 2021, the app is still in alpha.

Instant loans from Benqi Finance’s lending protocol, which is close to launching on the Avalanche network, are also under development.

Why are Flash Loans dangerous?

The advantages of instant loans began to be used not only by developers and crypto traders, but also by cybercriminals. In February 2020, there were two attacks on DeFi protocols using flash loans with a total damage of $ 1 million. They exploited a vulnerability in the bZx protocol, which allowed manipulating the prices of crypto assets and artificially inflating them in order to extract profit. The instant loans themselves were not vulnerable, but served as a very cheap source of funding for attacks.

During 2020, Flash Credit Attacks became one of the most commonly used ways to steal funds from various DeFi protocols. Most of the attacks undertaken exploited vulnerabilities associated with the unreliability of the used price oracles and the ability to manipulate asset prices.

In the spring of 2021, instant loans became available on several EVM-compatible networks at once – and this gave rise to a whole series of attacks on DeFi protocols, primarily on the Binance Smart Chain (BSC) network.

In May 2021 alone, as a result of attacks on the BSC network, decentralized services lost a total of $ 167 million. The largest attacks were on Belt Finance projects (damage in the amount of $ 50 million) and Pancake Bunny, which lost $ 45 million in assets. Other victims include BurgeSwap. ApeRocket, bEarnFi and a number of other BSC-based DeFi projects.

What are Flash Loans?

Instant loans or flash loans (from the English. Flash Loans) is a function in a number of popular DeFi-protocols that allows you to borrow cryptocurrency assets without collateral, with the condition that the debt will be returned in the same block of transactions.

Flash loans have become one of the most significant events in the world of decentralized finance in 2020, bringing profit to some market participants and losses to others.

How and when did Flash Loans appear?

Since the beginning of the development of decentralized lending, all loans in cryptoassets required the borrower to provide excess collateral (collateral). That changed in January 2020 when UK-based lending company Aave launched a decentralized lending protocol based on liquidity pools. Instant Unsecured Loans have been made available to third party DeFi developers.

The basic requirement for a flash loan is simple: transactions for obtaining and repaying a loan, as well as any intermediate transactions with issued funds, must occur within one block of transactions. For this reason, it takes only a few seconds from borrowing to paying off the loan. At the same time, the size of an instant loan can reach tens of millions of dollars, and the commission for its issuance is only 0.09% of the amount (in addition to the cost of gas for accessing smart contracts).

DeFi application developers appreciated the huge potential of instant borrowing almost immediately after opening Aave’s documentation for this feature. However, they became really in demand after a few months, with a manifold increase in the number of users of DeFi services and a subsequent increase in commissions on the Ethereum network. Conventional DeFi transactions were too expensive, and the use of instant borrowing strategies significantly reduced transaction costs and found new opportunities to generate profits.

At the end of 2020, the Aave landing platform processed $ 2 billion in flash loans, and by the end of the first half of 2021, this amount had grown to $ 4.2 billion. According to the service AaveWatchThe largest instant loan was $ 195 million.

In the first half of 2020, the flash credits feature became available to users of the dYdX decentralized trading platform. An analogue of instant loans can be considered the function of flash swaps, which was offered in May 2021 by the popular decentralized crypto exchange Uniswap in the version of the protocol v2.

Users were able to lend without collateral for more than 100 tokens that can be used for arbitrage transactions (for example, between Uniswap and SushiSwap) and other strategies. This function can only be accessed through smart contracts, as there is no user interface. The loan cost is 0.3% (excluding gas fees and Uniswap fees).

When to use instant loans?

The opportunity to obtain cheap unsecured loans has opened up many opportunities for users of DeFi services, both to profit from market inefficiencies and to reduce the cost of lending and other operations. Below are the most common use cases for Flash Credits.

Arbitration trade

Making a profit from the exchange rate difference of one asset on different trading floors implies the use of a large amount of your own funds. Instant loans become a source of cheap financing for such operations according to the following scheme:

• take a flash loan for this asset from the DeFi protocol;
• use borrowed funds to buy an asset on the DEX where it is cheaper;
• sell an asset on the DEX where it is more expensive;
• return flash loan with commissions and interest.

It is arbitrage trading that is considered the most popular use case for flash credits.

Self-liquidation of debt positions

When the value of the collateral falls below the value of the borrower’s debt, the lending protocols trigger an automatic liquidation procedure. Part of the collateral is sold to pay off the debt, while a liquidation penalty is charged, which, for example, on Aave is 5% or 10% (depending on the type of collateral), and in the case of Vaults of the MakerDAO service – 13%.

The use of instant loans allows, without waiting for this expensive procedure, to carry out a much cheaper self-liquidation without fines according to the following scheme:

• take a flash loan for this asset;
• repay the debt with borrowed funds and thereby release the security deposit;
• to use part of the security deposit to pay off the flash loan with the corresponding commissions and interest.

Quick replacement of collateral

Replacement of loan collateral may be required, for example, when the price of the collateral asset falls, when the risk of liquidation increases. In this case, it is reasonable to replace the falling asset with a growing or less volatile crypto asset.

Conventional collateral replacement requires full debt repayment and then reopening, which increases transaction fees and requires full debt. Flash loans allow you to do this much faster and cheaper by combining all transactions in one block.

Fast refinancing of loans

Lending rates on various DeFi platforms are constantly changing depending on market conditions and available liquidity. Flash loans have proven to be a convenient tool for cheap “transfer” of credit to platforms with lower rates, including the exchange of collateral for another asset.

How to use instant loans?

Initially, the instant loans feature was open only to developers. There was no public user interface, and access to this function was only possible through smart contracts. However, in 2020, third-party services appeared that provided access to Flash credits to users who did not own Solidity.

CollateralSwap

This service with the most simple interface can only work with the MakerDAO service so far, performing two tasks:

• quick replacement of collateral without having to pay off outstanding debt (for example, replace ETH with USDC);
• self-liquidation of a debt position without fines.

In both cases, the CollateralSwap fee is 0.29%.

DeFi Saver

It is a DeFi application that works with the MakerDAO, Aave, Compound, dYdX and Reflexer protocols and gives users the flexibility to manage assets and loans. The Recipe Creator option makes it easy to create your own strategies using Aave and dYdX Flash Credits.

Furucombo

This is an application that allows you to create your own DeFi strategies, called “combos”, using visual programming. Each transaction in a “combo” is displayed as a cube. The user can customize the parameters of the cubes and their order. Then the service combines all the cubes into one transaction and sends them for execution. Aave Flash Credits are the basis for many of the boilerplate “combos” available in this app.

Are there flash loans in alternative ecosystems?

With the growing popularity of EVM-compatible blockchain platforms (Binance Smart Chain, Solana, Avalanche, Polygon, Fantom) in the first half of 2021, the flash credit function became available to users of these networks.

In April 2021, the Aave protocol was deployed on the Polygon network. Since then, users have been able to use instant unsecured loans in the same way as before on the Ethereum network with the same 0.09% commission. Of course, with the difference that all transactions in the Polygon network cost thousandths of a cent…

At the same time, in April 2021, the CREAM Finance project offered its version of flash credits on the Binance Smart Chain. Later, this feature became available on the Polygon and Fantom networks. At the same time, the commission of the CREAM protocol is only 0.03%.

Other flash lending platforms on the Polygon network include UniLend Finance. An unsecured borrowing of the MATIC token is available for users with a commission of 0.05%.

On the Solana network, the Solaris Protocol landing platform is about to offer Flash Credits. As of summer 2021, the app is still in alpha.

Instant loans from Benqi Finance’s lending protocol, which is close to launching on the Avalanche network, are also under development.

Why are Flash Loans dangerous?

The advantages of instant loans began to be used not only by developers and crypto traders, but also by cybercriminals. In February 2020, there were two attacks on DeFi protocols using flash loans with a total damage of $ 1 million. They exploited a vulnerability in the bZx protocol, which allowed manipulating the prices of crypto assets and artificially inflating them in order to extract profit. The instant loans themselves were not vulnerable, but served as a very cheap source of funding for attacks.

During 2020, Flash Credit Attacks became one of the most commonly used ways to steal funds from various DeFi protocols. Most of the attacks undertaken exploited vulnerabilities associated with the unreliability of the used price oracles and the ability to manipulate asset prices.

In the spring of 2021, instant loans became available on several EVM-compatible networks at once – and this gave rise to a whole series of attacks on DeFi protocols, primarily on the Binance Smart Chain (BSC) network.

In May 2021 alone, as a result of attacks on the BSC network, decentralized services lost a total of $ 167 million. The largest attacks were on Belt Finance projects (damage in the amount of $ 50 million) and Pancake Bunny, which lost $ 45 million in assets. Other victims include BurgeSwap. ApeRocket, bEarnFi and a number of other BSC-based DeFi projects.