If you want to borrow money from traditional banks, you will need to provide various documents,
such as a
formal ID and proof of income. A flash loan does not require any of these documents. These loans
are
instantaneous so that users can get funds quickly. Many argue that flash loans are very useful
and
innovative in
cryptocurrency. However, cybercriminals can also exploit them to take advantage of
protocols that
are
not well protected.
Let's dive deeper into flash loans to find out who is lending them and the risks.
What is a DeFi Flash loan?
The flash loan is a relatively new type of uncollateralized loan that traders can access using
some
Decentralized Finance (DeFi) protocols based on an Ethereum
Blockchain
Network (Ethereum).
This loan type allows traders to borrow unsecured loans directly from the lender without
intermediaries.
Because flash loans allow users to trade and arbitrage in new ways, they have become very
popular.
What makes Flash Loans so unique?
We are all familiar with the concept of flash loans.
Lenders lend
money to borrowers, and then they are paid back with some or no profit. The DeFi Flash Loan
transaction
looks similar, but flash loans have unique properties that make them more appealing to both the
borrower
and
the lender.
Smart Contracts
Smart contracts are flash loans. This feature is part of blockchain technology.
It prevents
funds from leaving one account without fulfilling certain obligations. The smart contract rules
ensure
that
the borrower repays the loan after a flash loan is issued. The smart contract will reverse the
transaction
if this condition is not met.
This ensures the safety of funds in the reverse pool.
Unsecured Loans
Traditional lending requires that borrowers have collateral swaps
and
arbitrage to lend money. If the borrower fails to pay the loan terms, the lender can
still
recover
the collateral. An unsecured loan does not mean that the lender won't receive their money back
if things
go
wrong. They will get it back in another way.
Instantaneous Transactions
There are many steps involved in obtaining a loan. A person approved for a loan will likely repay
it by
depositing a certain amount over some time. The process of getting a flash loan in decentralized finance protocols is instantaneous. The DeFi
flash loan
process has three steps:
- You receive the loan.
- You use the loan to produce.
- You pay back the loan.
This may seem not very easy for beginners, so let's simplify it. You can ask a lender for a quick
loan of
$50,000 in ETHLENDER. After they approve you, you will
have $50,000
in
borrowed capital available for trade. However, you must repay the loan within the same
transaction. This
usually takes only a few seconds. Although it may sound strange, this is because we have
modified our
thinking to work with traditional transactional methods.
You should note that the smart contract transaction can be reversed if you are unable or unable
to repay
the
loan.
Where can you get Flash Loans?
Although flash loans are becoming more popular in crypto, they are unavailable for traders on all
trading
platforms. These are some flash loans in DeFi platforms
that offer
flash loans to traders:
AAVE
Aave is the leader in flash loans. Aave flash loans can be used by Defi
traders using Aave V2 to swap and migrate positions. These loans are a great option
due to:
They can arbitrage among assets without having the principal amount required to execute an
arbitrage.
- They permit the swapping of collateral for loan positions without paying the loan debt.
Other DeFi Flash loan platforms:
- DyDx
- Decentralized Exchange (DEX).
- Uniswap
Why would you use a flash loan?
Flash loans allow traders to profit while not putting their money at risk. You can use them for
the
following:
Arbitrage opportunities
Traders use flash loan transactions to profit from price discrepancies between price exchanges.
They also
exploit time. A trader may use a flash loan and separate smart contracts to buy tokens on one
exchange for
$2,000 and then sell them on the other exchange for $2,500. This generates a $500 profit. The
trader then
repays the loan and keeps the profits.
Collateral Swaps
- This is where one collateral is used to replace the other to secure the loan.
- Transaction fees reduced
- The service fee for a flash loan is lower because it combines multiple transactions into one
(in
certain
cases). So the borrower pays lower fees, and the transaction cost is charged to the loan
amount.
Flash Loan Transactions Are Risky
Over the years, there have been numerous attacks on flash loans that have led to millions of
dollars in
losses for vulnerable Defi protocols. As malicious actors
continue
to
exploit the loaning system in various ways, the technology behind Defi and the Ethereum network
could be
improved.
Hackers can exploit loopholes in smart contracts that aren't always constructed correctly.
Sometimes the
data received can be an inaccurate or unsecured loan. This
makes
smart
contracts vulnerable to hackers, who may steal millions of dollars in loan capital.
What is a Flash Loan Attack?
Flash loan attacks, a form of DeFi attack, are where cyber thieves take out loans from lending
protocols
to
manipulate the market. They exploit smart contract vulnerabilities to cheat another party or
introduce
unwelcome modifications to the smart contract's code. These are the most popular type of DeFi apps development attacks because they are easy
to commit.
They've also become more common in recent years, with several high-profile attacks appearing in
the media.
Flash loans, as mentioned above, allow users to borrow large amounts on various exchanges even if
they
have
zero capital. Although the loan is instantaneous, you will need to use the borrowed funds to
repay them.
Flash loan attackers can borrow large amounts of money because decentralized lenders don't
require
collateral. They can manipulate crypto-asset funds and resell them on other exchanges.
The most frustrating thing about the attack is that they can manipulate the market and still
follow the
rules. They can also do it multiple times without leaving any trace and steal millions of
dollars.
Flash Loan Attacks: well-known examples
Recent flash loan attacks seem to be on the rise. These are just a few examples of high-profile
attacks
that illustrate how easy it is to perpetuate these attacks.
dYdX: In the case of the dYdX Flash Loan Attack in early 2020, an attacker used the platform to
obtain
the
loan. He then divided the loan income and used it on Compound and Fulcrum lending platforms.
Fulcrum was
forced to purchase WBTC because Fulcrum used the first portion of the loan to shorten ETH.
Fulcrum ordered
WBTC through Uniswap. However, due to Uniswap's low liquidity, the price of WBTC soared
significantly.
Fulcrum, therefore, had to pay more.
The attacker used the remainder of the dYdX loan to take out a WBTC loan via Compound. The
attacker
borrowed WBTC and flipped it on Uniswap to make profits. The attacker then paid off their loan
to dYdX and
took the rest of the ETH.
Pancake Bunny: Pancake Bunny’s most recent flash loan
attack
occurred
in May 2021. An exploit caused Pancake Bunny’s token to drop 95% from its original value.
Pancake Swap
borrowed many BNBs to manipulate Pancake Bunny’s pools' prices. The price of BUNNY crashed after
a large
amount was stolen and then dumped onto the market.
CREAM Finance: This protocol was also attacked several
times in
2021.
The largest heist involved $130 million. They used multiple flash loans to manipulate the price
of the
oracle. They could get away with CREAM liquidity tokens worth millions of dollars.
Flash Loan Attacks: Can you stop them?
Flash loan attacks remain frustratingly common in DeFi
wallets so
it
is obvious that there are no one-size-fits-all solutions. There are, however, steps you can take
to
prevent
them.
Prices oracles
Flash Loans are often viewed as a vulnerability in DeFi. Flash loan attacks are just attacks on
Oracles.
Third-party services such as ChainLink and WitNet that connect smart contracts to the noncustodial decentralized wallets world include Provable,
WitNet, and
WitNet, all blockchain oracles. They allow you to securely transfer off-chain data into a blockchain network's On-chain environment.
Top Defi protocols use decentralized networks with oracles to account for liquidity and volume
differences
across multiple exchanges. They are therefore more resistant to flash loan-funded manipulation.
Security platforms DeFi
The delay in the response time of DeFi platform developers is a key factor that allows cyber
thieves to
execute flash loans. Open Zeppelin Defender is the most popular security platform.
Open Zeppelin Defender enables project managers to spot smart
contract
development exploits and unusual activities. This allows them to react much quicker
and take
immediate action to stop the attacks. You might also find our article interesting on why
security audits
no
longer work for DeFi.
A turning tide for Flash Loan attacks
Flash Loans are an important tool in DeFi. Although they are vulnerable to many attacks, the tide
is
changing. These attacks will likely decrease with more thorough research, improved security
tools, and the
use of pricing oracles.
Flash Loans are still in their infancy, and many of their potential uses are not yet fully
explored.
Others
believe they will be used to fund innovative projects, such as buying tokens and borrowing money
to
finance
governance votes. Contact PerfectionGeeks
Technologies, as we keep you updated with the latest trends and technologies. Flash
Loans have a lot
of future potential, so let's keep an eye on this.