How To Make Money With Flash Loans

Flash loans have made headlines in the crypto space for reasons both skillful and bad. While they’ve been implemented to exploit many vulnerable DeFi protocols, they’ve besides helped many users make a profit. Some enthusiasts even debate that they’re one of the most innovative blockchain technologies.

Merely what are flash loans exactly?

This article explains how flash loans work and outlines some of their virtually common applications.

What are flash loans?

Flash loans are uncollateralized loans without borrowing limits in which a user borrows funds and returns them in the same transaction.

If the user tin’t repay the loan before the transaction is completed, a smart contract cancels the transaction and returns the money to the lender.

Why do flash loans be?

To empathize why flash loans were created, let’due south wait at existing lending systems in centralized and decentralized finance.

Centralized Finance (CeFi) lending systems

The most common loans in traditional finance are
secured loans
and
unsecured loans.

A secured loan requires the borrower to provide a form of security called
collateral
to the lender for the repayment of a loan.

Collaterals commonly apply to large sums of money and help the lender compensate their losses by selling the assets if the borrower can’t repay the loan.

For example, if you’re taking out a mortgage, your home will become the collateral, and the lender will sell it to cover the mortgage if you default.

An unsecured loan, on the other hand, is one in which the borrower doesn’t take to provide collateral to borrow funds. If the borrower defaults, the lender sells the collateral to get their loan money dorsum.

A picture showing the working of a centralized lending system.
Centralized lending process

In both cases, the borrower has to pay involvement. And in both cases, if the borrower defaults, the lending authority has to bear the brunt of the losses.

Decentralized Finance (DeFi) lending systems

DeFi lending systems operate differently than their traditional centralized counterparts. They puddle capital from depositors into a “liquidity pool” to offer collateralized loans for borrowers.

Near of these loans are over-collateralized, meaning the borrower has to provide collateral in crypto that is worth more the borrowed assets. This is to account for fluctuating crypto prices and ensure that the nugget doesn’t become undercollateralized.

A picture that shows how decentralized lending protocols work.
Decentralized lending

In other words, if the collateral’s value tin can no longer cover the debt, the platform will sell collateral at a discounted toll to repay a part of the loan. This process is called liquidation.

Wink loans address the limitations of CeFi and DeFi lending

CeFi and DeFi loans too have some disadvantages that wink loans address.

In a traditional CeFi lending organisation, y’all’d have to wait months to go your loan approved. Simply cheers to smart contracts, flash loans are processed and approved instantly.

Also, if the borrower defaults, the onus of debt is on the lending authorities. If a borrower defaults on a flash loan, however, the smart contract volition cancel the transaction and return the funds to the lender.

Equally for DeFi lending, users take to provide collateral to get a crypto loan. Flash loans, on the other mitt, are uncollateralized, making lending more accessible and giving everyone the opportunity to make money.

How practice flash loans work?

There are two main entities in a wink loan: the
lender
and
borrowers.

To interact with the flash loan lender, borrowers must develop a smart contract that consists of three parts:

  • Borrow
    loans from wink loan lenders (Aave,
    dYdX,
    and
    Uniswap)

  • Interact
    with smart contracts for other operations

  • Return
    the loans

The unabridged workflow consists of five steps:

1. Transfer loan

The flash loan provider transfers requested avails to borrowers.

2. Invoke

The user invokes pre-designed operations.

three. Run operation

The user interacts with different smart contracts to execute operations (arbitrage, liquidation, etc.) with borrowed assets.

4. Repay loan

Once the operations are consummate, the user will return the avails to the flash loan providers with or without the borrowed assets.

five. Bank check country

Lastly, the flash loan providers will check their balance. If the user has submitted insufficient funds, the providers will contrary the transaction immediately.

A picture showing the steps involved in a flash loan transaction.
An example of a flash loan transaction

The 3 nigh common uses of wink loans

Flash loans have a broad variety of applications that range from paying off debts to making profits from trading. Here, nosotros talk over the three of the nigh common use cases.

1. Arbitrage

Arbitrage is the strategy of leveraging price differences for the same asset in different coin markets to make a profit.

Buyers and traders can
purchase crypto
at low prices and run it through different exchanges to end up with slightly more crypto than before. Although this cost exploitation sounds harmful, it contributes to market efficiency.

As more than crypto traders seek to exploit the same toll discrepancy, the prices of these avails across unlike exchanges volition converge, leading to uniformity of the crypto market.

A picture that shows how crypto arbitrage yields profits.
Crypto arbitrage

If you’re just starting with crypto arbitrage, you probably don’t accept enough assets to make a significant turn a profit.

Only flash loans give y’all the ability to borrow as much as you want, then you lot can make a decent profit if you lot find assets with a considerable cost difference.​​ Here’due south a transaction from Etherscan that shows how you tin can use a flash loan to profit from arbitrage:

A picture of a crypto arbitrage transaction that yielded $16,000 in profit.
A crypto arbitrage transaction that yielded $16,000 in profit

First, the user borrowed 2,048,000
USDC
using dYdX’s flash loan. And so, they swapped the amount for 2,028,367 DAI on Curve y puddle.

Next, they used the ii,028,367 DAI to buy 2,064,182 USDC on Bend’southward SUSD pool, after which they paid back the flash loan and kept the difference worth $sixteen,182.

2. Wash trading

Similar any other fiscal engineering, flash loans can also be used to scam users. Wash trading is one such apply case.

Wash trading is the process of using a group of trades to create an illusion of college merchandise volume. It misleads investors and other users into thinking that a cryptocurrency or
NFT has high need when information technology doesn’t.

Some countries similar the US have banned the practise of launder trading, only the practice has seen a revival in the crypto market place considering of the lack of centralized institutions and regulations.

Now, with the appearance of wink loans, launder trading has become more rampant as traders tin can become concur of a large sum of crypto to manipulate the market.

Hither’due south a transaction from Etherscan that will help y’all sympathise wash trading amend:

A picture of a wash trade transaction.
A launder trade transaction

First, the user borrows 0.01 Wrapped Ether (WETH) from
dYdX. So, they exchange it on Uniswap to get ~122.189 LOOM, which is converted dorsum into ~0.0099 WETH.

Afterwards this pace, the user pays back the flash loan to dYdX. What distinguishes this transaction from arbitrage or other types of legal transactions is that at that place was a loss while swapping tokens.

This indicates that the user’s primary aim was to increase trading volumes and not turn a profit from the transaction, making information technology an illegal trade that was solely done to dispense the market and create artificial need for avails.

three. Closing Collateralized Debt Position

A Collateralized Debt Position (CDP) is simply a crypto loan that’s backed by collateralized avails. In one case the user borrows funds, the platform locks the collateral until the loan is repaid.

During this menses, if the currency of the loan drops in value compared to the currency of the collateral, the user tin can’t repay the loan.

Flash loans allow you to pay back the loan and release the collateral so you tin utilize it for other purposes. Hither’s a transaction that explains the concept better:

A picture of a Collateralized Debt Position (CDP) transaction
A CDP transaction

Start, the user takes a flash loan equal to the debt (~262.17 DAI.) from Aave. Next, they repay the loan on Maker, and the platform releases their collateral (ii.09 WETH).

Then, they go to Kyber reserve to convert their WETH into DAI and transfer the surplus amount (~2 DAI) to Uniswap for other purposes. Lastly, the user pays back the loan to Aave, which burns a fraction of its token for 0.07 DAI to increment the value of its tokens in circulation.

Tin can you make coin with flash loans?

When a debt becomes undercollateralized, a form of users chosen
liquidators
volition trigger a liquidation event to buy undercollateralized assets at discounted prices.

With flash loans, anyone can go a liquidator and profit from the discounted assets. For example, take a look at this transaction:

A picture of a transaction that shows how liquidators use flash loans to profit off liquidations.
Liquidation

Kickoff, the user borrows 12,940 DAI from dYdX and swaps information technology for 13,046 USDT. This
USDT
is then used to purchase collaterals at a discounted price on Compound.

Subsequently exchanging the asset they bought, the liquidator gets 13,450 DAI. And once they paid back the flash loan, 510 DAI remained as profits, which is greater than the
gas fees
(~$172).

What are wink loan attacks?

Although DeFi flash loans have grown in popularity and liquidity, they’re far from perfect.

Well-nigh $500 meg
worth of assets were looted from DeFi platforms between 2020 and 2021. And ane of the most mutual attacks that caused millions to be wiped off the protocols were carried out using flash loans.

Oracles
are third-party services that allow smart contracts to get information from outside their ecosystem. In nearly cases, this data is the existent-fourth dimension cost of assets.

Oracle manipulation is the practise of manipulating the asset price information in these oracles to buy or sell in a higher place or beneath the off-white market price on the platform.

Here’southward how this attack is carried out using a flash loan:

  • Borrow
    a big amount of token A from a flash lending provider

  • Use
    a DEX to merchandise token A for token B (this lowers the price of token A and increases the price of token B on the DEX)

  • Utilize
    the purchased token B every bit collateral on a DeFi protocol that relies solely on the DEX (mentioned in a higher place) as its price feed, and apply the rigged pricing to borrow a larger amount of token A.

  • Profit
    from the protocol’s manipulated toll feed by using a portion of borrowed token A to fully repay the original wink loan and proceed the remaining tokens.

  • The values of tokens A and B on the DEX will be arbitraged dorsum to the true market place price. Only the DeFi protocol is left with an undercollateralized position (debt worth more than collateral), which directly harms other users such as the liquidity puddle providers.

For case, in May 2020, the
Binance Smart Chain
protocol Pancake Bunny
lost over 7 meg BUNNY tokens
and 114,000 BNB in a wink loan attack.

As a outcome of the set on, BUNNY plummeted by 96% and the platform incurred a loss of more than $200 million.

How tin you protect yourself from flash loan attacks?

Protocols that apply on-chain centralized toll oracles, such as a single DEX, are vulnerable to attacks carried out using flash loan vulnerabilities.

Why?

When a single on-chain exchange is used as a price feed, an asset’s data is extremely express considering it only reflects the market condition of that one commutation.

An oracle similar
Chainlink, however, is powered by a decentralized network of oracles, then while an attacker tin can conduct out a unmarried flash loan transaction, it still won’t affect the cost feed as the exchange gets pricing information from multiple sources.

Concluding thoughts

Wink loans have taken the decentralized finance earth by storm equally they allow users instantly infringe unlimited assets without collateral.

They’re a double-edged sword, nonetheless, and can have unfavorable consequences on the crypto ecosystem depending on what they’re used for.

Many crypto enthusiasts are currently using flash loans to make profits and hedge themselves confronting liquidation risks. But malicious parties are besides using them to engineer attacks on smart contracts and drain them of funds.

Yet, the risk of these attacks might diminish in the hereafter if DeFi platforms spend more resources on testing their code.

Information technology’s also worth remembering that flash loans are relatively new to the DeFi space, so the possibilities for innovation are endless.

Frequently asked questions (FAQs)

How do I become a crypto flash loan?

To get a crypto flash loan, yous can use a drag and driblet tool like
Furucombo
and create a pipeline with cubes which are alike to building blocks.

All you’ve got to do is go to the Create mode, click the “+” on the cube icon and choose from different options. You tin can reorder the cubes according to the order in which the transaction should be executed.

Just ensure that y’all nest intermediate actions like token swaps between the two flash loan cubes as shown below.

A picture of a flash loan transaction on Furucombo. 
How a flash loan transaction is carried out on Furucombo

Alternatively, yous can also use smart contracts to execute wink loans on platforms like Aave, dYdX, and Uniswap.

Since smart contracts are pieces of lawmaking, you can discover many open source flash loan codes on sites like GitHub.

Practise flash loans demand collateral?

No. Wink loans are unsecured and uncollateralized, pregnant anyone can borrow funds to make profits.

What happens if yous don’t pay your wink loan?

If you don’t pay your wink loan, the lender’s smart contract cancels the loan and returns the funds to the user.

How long does a flash loan last?

Equally the name suggests, a wink loan only lasts for a few seconds or minutes every bit the loan is taken and repaid inside the same transaction.

Are flash loans risk free?

Yes. Lenders don’t have to worry about defaulting and can lend big amounts while borrowers don’t run the hazard of liquidation.

Brainstorm your DeFi journey with MoonPay

Wink loans are just i of the many ways you tin can appoint with the DeFi ecosystem.

Buy cryptocurrencies via MoonPay
using your credit card or whatsoever other
preferred payment

method to get started on your DeFi journey today.

Source: https://www.moonpay.com/blog/defi-flash-loans-explained

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