To obtain a loan from a traditional bank, you must provide documents and go through validation and eligibility processes. However, this process is not necessary for a crypto flash loan. The whole process happens instantly, allowing users to access these loans and repay them almost immediately.
Flash loans are innovative in the crypto space. They are very useful but can also be manipulated by attackers. Keep reading to find out how these flash loans work and how you can protect yourself from attacks.
What is a Flash Crypto Loan?
Flash loans are unsecured loans that have gained popularity in the crypto space. These are unsecured loans that some DeFi platforms make available to investors. These loans are considered unsecured as they do not require you to have any collateral before accessing them.
To access a flash loan, a smart contract is built on the blockchain that asks to borrow money. Achieving this may require developer knowledge and coding skills. However, some tools allow users to access flash loans without coding knowledge, such as Warranty exchange and DeFi Saver.
3 key flash loan features
Flash loans have the following special properties.
1. Unsecured Loans
This means you don’t need to secure it with any form of collateral, deposit or assets to get it. There is also no need for a credit check.
2. Smart contracts
Smart contracts ensure that all processes are done in a single transaction. For example, the loan process will be reversed if you do not return the funds as part of a transaction. This process also ensures loan security and reduces risk for lenders.
3. Instant Transactions
We are used to a borrowing system where we borrow money, use it for a certain time, and then return it for a set period. It is not the same as flash loans. Once you get a flash loan, you need to execute almost immediate transactions using smart contracts and return the money before the bulk transaction is complete. The whole process usually happens in a flash.
3 Uses of Crypto Flash Loans
You’re probably wondering why you need a flash loan because you can’t hold it for long and can’t use it to buy a house or other physical assets. In short, it’s not for that.
So what are flash loans for?
1. Arbitration negotiation
One of the main reasons traders take out flash loans is to make money from the small price differences that occur on different exchanges. Arbitrage trading works by using a huge amount of traders’ funds to make money, and getting a crypto flash loan is one way to get easy funding for such moves.
You do this by taking out a flash loan and then using it to buy an asset on an exchange where it is cheaper. You then sell it on an exchange where it is more expensive. After this process, you repay the flash loan with fees and interest. It’s a three-step process: get the loan, use the loan, and repay the loan, all in one transaction.
2. Warranty Exchange
In this case, the collateral used to secure the user’s loan is used to replace another type of collateral.
3. To save transaction fees
Flash loans sometimes bundle multiple transactions into one, reducing transaction costs. The cost of the transaction is usually deducted from the loan amount, so the parties involved benefit from lower fees.
What is a Flash Crypto Lending Attack?
The ability to obtain loans without collateral has led to the rise of many flash loan attacks. A flash loan attack occurs when an attacker takes out large flash loans and uses the fund to manipulate market prices and exploit DeFi protocols. These malicious agents usually profit significantly from these moves, which comes at the expense of regular investors.
Flash lending attacks can also be carried out by exploiting vulnerabilities in a platform. Attackers are usually very quick with the process because they know they have to pay off the debt in one transaction. As mentioned earlier, an unpaid flash loan is canceled as if nothing had happened. Flash loan attackers are trying to devise new ways to manipulate the market without going against blockchain protocols.
Flash loan attacks are common in DeFi because they are low risk and high reward. They are affordable because all you need to make them is your computer and an internet connection. There is usually no trace after the deed has been committed, making it difficult to trace flash loan attackers. Moreover, the loans are used to carry out all the actions, so it does not require a lot of capital to carry out.
Reduce risk of loan blitzes
Here are some precautions you can take to reduce the risk of falling victim to a flash loan scam:
Decentralized Pricing Oracles
Using decentralized pricing oracles can help curb price manipulation caused by flash loan attacks. These decentralized oracles, like Chain link and band protocol, use different sources to determine the exact prices of different cryptocurrencies.
The pricing oracle will frustrate attackers’ price manipulation, and the whole process will reverse as the transaction time elapses.
High frequency price updates
Here, liquidity pools more often consult decentralized oracles for pricing. With this, the price of the token is updated, which will invalidate price manipulations.
Flash loan attack detection tools
Some platforms are taking on the security challenge of flash loans. An example of such a platform is OpenZeppelin. The platform launched OpenZeppelin Defender, which helps detect smart contract attacks and unusual activity, helping developers neutralize attacks.
Only Take A Crypto Flash Loan If You Understand The Risks
Even with all the solutions that have been suggested, you have to remember that DeFi technology is not developed enough for you to be complacent as hackers often find new vulnerabilities.
Developers can only get by for now by making the most of the solutions they currently have. If these solutions don’t work, they will learn something new each time they are attacked. There is also the hope that as smart contracts get stronger and more systems use security tools and decentralized oracles for pricing, we will see fewer hacker attacks.