Flash Swap

Users of lending protocols like Aave or Compound can use flash swaps to change their collateral type or repay debt efficiently.

• Example: A user can flash-borrow ETH, use it to repay a USDC loan, withdraw their original collateral (e.g., WBTC), sell some of it for USDC to repay the flash loan, and end with a different collateral portfolio. This avoids liquidation risk and saves on gas versus multiple separate transactions.

Liquidators use flash swaps to profit from unsafe loans on lending platforms without personal capital.

• The liquidator flash-borrows the debt asset (e.g., USDC).
• They repay the undercollateralized loan on the lending protocol, receiving the borrower's collateral at a discount as a reward.
• They sell enough of the collateral on the open market to repay the flash loan, keeping the remaining collateral as profit. This mechanism helps maintain protocol solvency.

A borrower facing imminent liquidation can perform a self-liquidation via flash swap to minimize losses.

• They flash-borrow the asset needed to repay their debt.
• They repay their loan to the lending protocol, withdrawing their full collateral.
• They sell a portion of the collateral to repay the flash loan.
• The user retains the remaining collateral, which is often more than they would receive after a liquidator's penalty fee, effectively giving themselves a better "discount."

A flash swap is executed via a single, atomic transaction. The user calls a smart contract (e.g., a DEX pool) to receive borrowed assets, performs an arbitrary operation, and repays the loan plus a fee—all before the transaction concludes. If repayment fails, the entire transaction reverts, eliminating counterparty risk for the lender. This is powered by the composability of smart contracts on platforms like Ethereum.

• Arbitrage: Exploit price differences between DEXs by borrowing asset A, swapping it for a more valuable asset B on another platform, and repaying the loan with the proceeds.
• Collateral Swaps: Replace collateral in a lending position without closing it, by borrowing the new collateral, using it to repay the old loan, and then repaying the flash loan.
• Self-Liquidation: Proactively liquidate your own undercollateralized position to avoid penalty fees, using a flash loan to repay the debt and reclaim remaining collateral.

Several major DeFi protocols pioneered and popularize flash swaps:

• Uniswap: The V2 and V3 pools have built-in flash swap functionality via the swap function with a callback.
• Aave: Offers flash loans (a similar concept) through its dedicated flashLoan function, often requiring a premium fee.
• Balancer: Enables flash swaps through its Vault architecture, allowing borrowing of multiple tokens in one transaction.
• SushiSwap: Also implements the Uniswap V2 style interface for flash swaps.

To execute a flash swap, a user must deploy or interact with a smart contract containing specific logic. This contract must:

1. Implement a callback function (e.g., uniswapV2Call) that the lending pool will invoke.
2. Within this callback, perform the profitable operation using the borrowed funds.
3. Ensure the contract has sufficient funds to repay the loan plus the fee by the end of the callback. The transaction's atomicity means all gas costs are paid upfront, but the principal is not.

While risk-free for liquidity providers, flash swaps carry execution risks for the borrower:

• Slippage & MEV: Front-running bots can extract value by sandwiching transactions.
• Gas Fees: Failed transactions still incur gas costs, which can be high during network congestion.
• Smart Contract Risk: Bugs in the borrower's contract logic can lead to failed repayment and lost gas.
• Oracle Manipulation: Some strategies rely on price oracles, which could be vulnerable to manipulation.

Flash swaps enhance market efficiency by enabling near-instantaneous arbitrage, which helps align prices across decentralized exchanges. They lower the capital barrier for sophisticated strategies, democratizing access to complex financial operations. The fee revenue from successful swaps provides an additional yield source for liquidity providers in pools that offer the functionality.

A malicious actor can use a flash swap to borrow a large amount of a token, manipulate its price on a vulnerable DEX, and repay the loan with the artificially cheap asset. This can be combined with a sandwich attack, where the attacker front-runs a victim's large trade with their flash swap, profiting from the price impact.

• Risk: Direct theft of liquidity from AMM pools.
• Mitigation: Implement TWAP oracles and strict slippage controls; use pools with concentrated liquidity.

Flash swaps can be used to create extreme, temporary price deviations on one DEX to manipulate an on-chain oracle (like a DEX-based price feed) that other protocols rely on. An attacker could then trigger undercollateralized loans or false liquidations on a lending platform.

• Example: Borrow a massive amount of ETH via flash swap, dump it on a low-liquidity pool to crash the reported price, trigger a liquidation on MakerDAO, then buy back ETH cheaply to repay the loan.
• Mitigation: Protocols should use time-weighted average price (TWAP) oracles from multiple sources.

The uniswapV2Call or equivalent callback function, which executes user-defined logic before loan repayment, is a prime attack surface. Malicious contracts can re-enter the lending pool or other connected protocols within the same transaction.

• Mechanism: The attacker's callback might make a recursive call back to the pool to borrow more assets before the initial debt is settled.
• Mitigation: Apply Checks-Effects-Interactions pattern and use reentrancy guards on all state-changing functions involved in the swap flow.

If the arbitrage or refinancing logic in the callback fails, the entire transaction reverts. However, protocol design flaws can lead to scenarios where the loan is not fully repaid, leaving the liquidity pool with bad debt.

• Scenario: A bug in the callback or an unexpected state change (e.g., a fee update) causes the profit calculation to be wrong, resulting in insufficient tokens for repayment.
• Mitigation: Pools must rigorously validate that the correct amount of tokens is transferred back before the transaction ends. Use balance checks instead of relying on internal accounting.

Flash swaps are a primary tool for Maximal Extractable Value (MEV). Bots compete to execute profitable swaps, leading to gas auctions and network congestion. While not a direct protocol exploit, this centralizes benefits to sophisticated players and degrades network performance for regular users.

• Impact: Increased transaction costs and front-running of user transactions.
• Systemic Risk: Can make blockchain usage prohibitively expensive during high volatility.

A flash swap attack on one protocol can cascade to others through integrated DeFi Lego systems. An exploited lending pool or manipulated oracle can cause liquidations, insolvency, or frozen withdrawals in dependent protocols.

• Example: The 2022 Mango Markets exploit used a flash loan to manipulate a price oracle, enabling the attacker to drain funds from the protocol.
• Mitigation: Protocols must perform risk isolation and assume that any price feed or liquidity pool can be temporarily manipulated.