Why Flash Loans Are the Ultimate Stress Test for Algorithmic Stablecoins

Flash loans transform any exploitable price lag or oracle weakness into a systemic risk. An attacker can borrow massive capital with zero collateral, execute a multi-step arbitrage or liquidation cascade, and repay the loan within a single transaction.

• Zero Upfront Capital: Attackers need only pay the gas fee.
• Scale Amplification: A single transaction can manipulate $100M+ in liquidity.
• Speed: The entire attack executes in ~13 seconds on Ethereum.

Algorithmic stablecoins like Terra's UST or Frax rely on external price feeds. Flash loans can temporarily distort the price on a DEX like Curve or Uniswap V3, creating a self-fulfilling depeg prophecy.

• Reflexivity: A manipulated price triggers redemptions or liquidations, further breaking the peg.
• Oracle Latency: Even a few seconds of stale data is enough for an attack.
• Liquidity Fragmentation: Attacks target the shallowest pool to maximize price impact.

Protocols with on-chain redemption mechanisms (e.g., mint/burn of LUNA-UST, FRAX-FXS) are vulnerable to recursive attacks. A flash loan can drain reserves by exploiting the arbitrage gap between the market price and the protocol's mint/redeem price.

• Recursive Liquidation: Triggers a positive feedback loop that collapses the system.
• Reserve Drain: The protocol's backing assets are extracted in a single block.
• Design Flaw Exposure: Reveals if the "algorithm" is just ponzi-nomics under stress.

Surviving a flash loan attack is the minimum viable requirement for a stablecoin. Protocols must design for worst-case capital efficiency, not average conditions. Solutions include time-weighted oracles (Chainlink), circuit breakers, and over-collateralization with robust liquidation engines (MakerDAO).

• Stress Test: Flash loans are a free, continuous audit.
• Design Imperative: If it breaks under flash loan pressure, the model is fundamentally flawed.
• Survivors: DAI and LUSD have withstood attacks due to their robust, conservative design.

The Iron Finance (TITAN) collapse demonstrated that reflexive feedback loops are a fatal flaw. A single actor used a flash loan to trigger a death spiral, proving that algorithmic stability without a hard asset backstop is just leveraged ponzinomics.

• Attack Vector: Flash loan used to mint massive IRON, then dump TITAN collateral.
• Fatal Flaw: Redemption mechanism created a reflexive, self-reinforcing sell pressure.
• Result: TITAN price fell >99.9% in hours, destroying the IRON peg.

Beanstalk's governance-as-collateral model was shattered by a flash loan-enabled governance attack. The exploit didn't break the peg mechanism directly; it hijacked the protocol's control system, showcasing that oracle and governance security are integral to peg defense.

• Attack Vector: Flash-borrowed $1B in assets to pass a malicious governance proposal.
• Fatal Flaw: On-chain price oracles and instant-execution governance.
• Result: Attacker drained the $182M protocol reserve in a single transaction.

While not a direct break, the Curve Wars established the template. Flash loans enable instant, massive concentration of governance power (ve-tokens) to manipulate pool weights and skew peg stability mechanisms. This is a slow-burn stress test on liquidity dependencies.

• Attack Vector: Borrow, vote, manipulate, repay—all within one block.
• Fatal Flaw: Stablecoin pegs overly reliant on incentivized, vote-directed liquidity.
• Result: Creates perpetual vulnerability to 'soft' peg attacks and economic capture.

Post-mortems of Iron Finance, Beanstalk, and Empty Set Dollar converge on one truth: algorithmic elasticity fails under extreme, coordinated sell pressure. The surviving models (Frax, DAI) hybridize with real-world or crypto-native collateral. Flash loans are the ultimate revealer of this structural weakness.

• Key Insight: Pure algo-stables are a Nash equilibrium vulnerable to a single defector.
• Survivor Bias: DAI's PSM and Frax's FXS/AMO model incorporate hard assets.
• Conclusion: The stress test proves the need for non-reflexive, exogenous collateral.

Flash loans enable attackers to temporarily distort the price feeds that govern collateral ratios and minting functions. This is not a liquidity drain but a protocol logic exploit.\n- Single Oracle Dependency is a fatal flaw for protocols like Terra's UST (Chainlink).\n- Attackers can borrow massive capital to move price on a DEX, trigger a de-peg, and profit from the resulting arbitrage death spiral.

Even with multiple oracles, concentrated liquidity in AMMs like Uniswap V3 creates a fragile price floor. A flash loan can drain the entire stablecoin pairing in one transaction.\n- This forces the protocol's arbitrage mechanism to work in reverse, burning the native token to defend the peg and causing hyperinflation.\n- The reflexivity between the stablecoin and its governance/volatility token becomes a doom loop, as seen with IRON Finance's TITAN.

Sophisticated bots don't just attack—they front-run the protocol's own stabilization mechanisms. When the system tries to arbitrage itself back to peg, MEV searchers extract the profit.\n- This taxes the recovery, leaving the protocol with the debt and the attacker with the gain.\n- It turns the algorithmic "self-healing" feature into a predictable, exploitable revenue stream for block builders and searchers.