Posted 2 weeks ago | by Catoshi Nakamoto
DeFi has a lot more to offer than just moving legacy financial services onto blockchain rails. It’s a whole new realm of technology that allows finance to operate in ways that just aren’t possible outside of the digital world. For example, a flash loan is an entirely new type of financial instrument that allows people to borrow millions of dollars without any credit or collateral. When was the last time you heard about a bank doing something like that?Read More
Let’s get it.
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In this video, we’re going to be talking about flash loans, one of the most interesting innovations in the world of decentralized finance.
This is one of those things that seems like it shouldn’t be possible, so it can be a bit hard to wrap your mind around the concept, but flash loans have quickly become a fundamental part of the DeFi ecosystem, and it’s important to understand how they work.
As you might have guessed, flash loans are loans that happen really fast. You won’t be able to take out one of these loans for a down payment on a car or anything like that though, because the loan needs to be repaid in the very same transaction that it was given. If the loan isn’t paid back in time, the transaction is cancelled and treated like it never happened.
The other interesting thing about flash loans is that you don’t need any collateral to borrow money. This means that you can borrow millions of dollars, no questions asked, as long as you return it right away. This is possible because the lender isn’t actually taking on any risk, since the transaction is cancelled if the money isn’t paid back immediately.
The borrower isn’t taking on any risk either because they don’t have to put up any collateral. Although, it will cost them some gas since flash loans are transactions on smart contract blockchains. All of the conditions for these loans are coded into smart contracts that only allow the transaction to go through if the money is reimbursed.
Flash loans are most commonly used for taking advantage of arbitrage opportunities, which is when a different price is shown for the same asset on competing exchanges. These opportunities are actually very common in crypto. That said, I do not offer any arbitrage services at all…ever. If you see my name connected with anything Arbitrage… IT IS A SCAM. Don’t fall for it.
With so many different exchanges in this space, crypto assets usually have a very small price difference depending on where they’re being traded. This price difference is typically 1% or smaller, which is hard to take advantage of if you don’t have a whole lot of money. This is where flash loans come in. If you have the technical knowledge, you can borrow millions of dollars to take advantage of these opportunities. With millions at your disposal to execute an arbitrage, 1% can end up being a whole lot of money, especially when you consider that your only risk was the gas spent on the transaction.
In addition to arbitrage, flash loans can also be used to swap collateral for other lending obligations, allowing traders to quickly move stablecoins into their collateral during times of volatility when they are risking liquidation.
It’s important to mention that people who are already whales can do the same thing too, if they want to make moves in the market without exiting their other positions.
An early DeFi platform called Marble was the first to introduce Flash loans back in 2018. It was one of the biggest innovations to come out of the crypto industry at the time – A new type of loan that is completely impossible in the traditional world. Unfortunately, we were in the middle of a brutal bear market and there wasn’t a whole lot of activity on the Ethereum blockchain back then, so Marble didn’t get used very much and eventually went out of service. Luckily, the developers at AAVE took note of this breakthrough and made flash loans available through their lending platform in January of 2020. After that, flash loans took off, with AAVE issuing more than $100 million in flash loans every day. In the month of June, AAVE issued almost $4 billion in flash loans.
For the most part, this is something that only developers and coders have had access to, but as we see with many things in crypto, new applications are slowly coming onto the scene to make everything easier to use. There are at least two platforms available that will allow you to use flash loans without any coding knowledge. One of them is called Furucombo… say that five times fast.
This application basically gives you a visual model of the various steps that you are going to take during the flash loan process. The interface allows you to drag and drop each component of the transaction into order, which is not possible with your average crypto wallet.
Other multi-service platforms like DeFi Saver have also been allowing their customers to interact with flash loans for the first time as well.
If you do decide to use any of these products, it’s important to remember that DeFi can still be risky at times. Many of these projects are still in beta format, and bugs are still being worked out.
Flash loans have actually received a lot of bad press over the years and have become heavily associated with high-profile hacks. This is a revolutionary new technology, but it has also created a new attack vector for smart contract platforms. One of the built-in protections that popular blockchains have is that it costs an insane amount of money to attack or manipulate them, but flash loans have lowered the financial barrier to entry for a variety of different attacks.
Flash loans allow potential attackers to borrow all the money they need to manipulate the markets or exploit vulnerabilities that would usually be impossible for them to reach. Flash loan attacks became a very big problem for DeFi platforms throughout 2020, but the hacks actually ended up making the network more resilient. Developers quickly learned that these attacks were possible because the vulnerable platforms were using centralized oracles, which made it very easy for hackers to manipulate price feeds. This is one of the reasons that you saw everyone rushing to partner with Chainlink over the past two years – Their decentralized oracle solution has been one of the best defenses against these attacks. So the next time you see a Link Marine, be sure to thank them for their service.
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If you’re new to crypto and wondering what oracles are, they are ways of passing information back and forth between blockchains so they can all stay up to date about what is happening across the markets. Without oracles, blockchains are in their own little worlds and don’t know about anything that is happening outside of their systems, which makes them much easier to exploit.
Chainlink has drastically reduced the rate of flash loan attacks in DeFi, but they continue to be a problem, especially on newer projects and platforms that use centralized oracles. This presents a risk for anyone who is providing liquidity or offering collateral to a DeFi service, so before parking your money somewhere, it’s best to do some research. Look into the history of the platform you’re using and see how they’ve handled problems in the past. Check to see if they’ve been hacked before, and if they were, find out if they paid back their users or just said “sorry about your luck” like that elven hipster from Kraken. Also take a look at what oracles they are using. Smart contact audits can be helpful too, but they don’t always prevent these kinds of attacks from happening.
As the DeFi ecosystem matures, new use-cases for flash loans will develop and things will evolve in ways that are impossible for us to predict now, but I’m excited to watch everything unfold.
But that’s all I got, be blessed. BitBoy Out!