Flash loans on DeFi. The pros and cons

Cryptocurrency trading is more than just buying an asset and selling it at an appreciated price. Over the past few years, cryptos have evolved with many features that resemble traditional finance.

One of these offers is the flash loan. How is the crypto flash loan different from other credit products? Let’s find out.

Flash loans use DeFi

First, flash loans are essentially a feature of decentralized finance (DeFi). Ethereum is the main DeFi enabler. On decentralized exchanges, cryptocurrency holders can stake their holdings. This is called yield farming, where income is earned by lending, not selling.

The loan borrower pays interest in the cryptos, which is the underlying revenue model. Aave and dYdX are two popular Ethereum-based DeFi protocols.

Flash loans are instant

Instant loans have also entered the traditional financial landscape. These pre-approved loans are granted without any hassle like numerous documents or a background check.

Flash loans in cryptos have similar underpinnings. A borrower can take out the loan in the desired crypto asset in no time. The transaction is recorded on the blockchain smart contract.

Read also: Best Cheap Cryptocurrencies With High Market Cap

Flash loans require no collateral

The main feature of flash loans is that they require no collateral from the borrower. This lowers the barriers to entry for new crypto enthusiasts. They can request cryptos from a lender, without having to demonstrate their ability to repay.

Flash loans are secure

At least in theory, flash loans on DeFi protocols are secured by smart contracts. The entire loan and repayment transaction is recorded in a single smart contract. The contract promotes self-adherence to the terms, and in the event of a breach of promise by either party, the entire transaction is void.

This means that the lender receives the cryptos if the borrower defaults.

Blitz attacks on loans

All is not as bright as it seems. A BSC-based protocol, Pancake Bunny, has been attacked by crypto scammers who manipulated the market using flash loans.

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By taking out large flash loans, any borrower can manipulate the price of the crypto asset in the broader market. The biggest problem is that the entire transaction is still completed because the manipulator repays the loan retaining the illicit profit made on the transaction.

Data provided by CoinMarketCap.com

Are flash loans on DeFi the future?

Instant crypto loans seem to be a promising aspect. And by avoiding the collaterals, the whole story seems more appealing. However, flash loan attacks highlight vulnerabilities. The worst part is that anyone can pull off an attack easily. If DeFi protocols can find a way out, flash loans could become a promising arbitrage tool in the hands of crypto investors.

Rosalie M. Dehner