What is a Flash loan ?
In the traditional economy, when a lender grants a loan to a borrower, there is always a risk the the borrower might not repay its debts bringing us to the
following question :
" What if it were possible to offer credit, without the risk that the borrower does not pay back the debt ? "
=> That is where blockchain-based flash loans come into play.
A flash loan is a loan only valid within one blockchain transaction that fails if the borrower does not repay its debt before the end of the transaction borrowing
the loan thanks to the blockchain capacity of reverting a transaction during its execution if the specified condition of execution are not fulfilled.
In other words, in the case of a flash loan the blockchain will automatically revert the transaction if the borrower has not repay its debt by the end of the block,
leaving as such the historic of the blockchain transactions unchanged as if the loan had never occured.
Flash loan properties
-
Borrowed and repaid in a single transaction
-
No collateral required
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Borrowers needs to returned the original borrowed amount + a small fee
-
Transaction needs to be completed sucessfully otherwise everything will be reverted, but the borrower will still have to pay the Gas fee.
Flash loan use cases
Arbitrage
Using flash loans, now anyone can utilize massive amounts of liquidity to arbitrage between multiple decentralized exchange without any barrier of
entry.
Debt refinance
Let's say you take a debt from a compound protocol at a 10% interest rate. But another protocol offers debt at 5%. In this case you can refinance your debt at 5%
without any collateral by using the following steps :
-
Borrow the flash loan from Aave protocol
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Pay your debt on the compound protocol
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Borrow on the second protocol at 5%
-
Payback your flash loan
Wash trading
The trading volume of an asset being one of the major metric of the trading popularity of an asset, the most popular assets are therefore supposed to be traded the
most. In this sense malicious exchanges or traders can mislead other traders by artificially inflating the trading volume of an asset to attract interests.
Yet, on the contrary of centralized exchange were wash trading of securities even though illegal under US law appears to be the norm among the majority of the
top 100 exchange (see this Market
Surveillance report), decentralized exchange were not really impacted until now due to the fact that it was requiring wash traders to hold and use real assets. However, with this new found
possibility of trading without no need of capital, it is most likely that wash trading will grow in the years to come in the crypto sphere.
