Flash Loan

The entire operation—borrow, execute logic, repay—must succeed within one transaction block. If repayment fails at any point, the entire transaction is reverted, meaning the loan never occurred. This atomicity eliminates principal risk for lenders, as funds are either fully returned or the state change is undone.

• No Partial Execution: The transaction is all-or-nothing.
• Enforced by Smart Contracts: Code, not trust, guarantees repayment logic.

Unlike traditional DeFi loans, flash loans require zero upfront collateral. Access to large capital is permissionless, based solely on the borrower's ability to craft a profitable arbitrage or liquidation strategy within the transaction. This dramatically lowers the barrier to entry for sophisticated trading and capital efficiency strategies.

• Capital Efficiency: Enables large positions without locking capital.
• Accessibility: Any Ethereum address with gas funds can attempt a flash loan.

The borrowed funds are used within a custom smart contract that executes a predefined strategy. This creates a "sandwich" structure: borrow -> execute -> repay. Common executable logic includes:

• Arbitrage: Exploiting price differences between DEXs (e.g., buying low on Uniswap, selling high on SushiSwap).
• Collateral Swaps: Refinancing debt positions in lending protocols like Aave.
• Self-Liquidation: Closing an undercollateralized position to avoid penalty fees.

Lenders profit via a small flash loan fee, typically 0.09% of the borrowed amount. The borrower's profit is the arbitrage or efficiency gain minus this fee and gas costs. Profit margins are often slim, requiring precise calculation.

• Fee Examples: Aave charges 0.09%, while some protocols have dynamic fees.
• Net Profit: Strategy Profit - (Flash Loan Fee + Network Gas Cost).
• Unprofitable Reverts: If fees and gas exceed gains, the transaction fails safely.

Risks are asymmetrical and fundamentally different from secured lending.

• Lender Risk: Near-zero principal risk due to atomic execution. Primary risk is smart contract bugs in the lending pool.
• Borrower Risk: High execution risk. If the programmed logic fails (e.g., slippage, incorrect pricing), the transaction reverts, but the borrower loses the gas fee paid for the failed attempt.

Flash loans are tools for capital efficiency, not personal credit. Primary uses are:

• DEX Arbitrage: The most common use. Example: Borrowing 1,000 ETH, swapping for an undervalued token on DEX A, swapping back for more ETH on DEX B, repaying the loan, and keeping the difference.
• Liquidation: Triggering the liquidation of an undercollateralized loan on Compound or MakerDAO to claim the liquidation bonus.
• Portfolio Rebalancing: Instantly swapping collateral types in a lending position without intermediate capital.

The most common use case, where a trader exploits price differences for the same asset across different decentralized exchanges (DEXs). A flash loan provides the capital to buy low on one platform and sell high on another, repaying the loan and pocketing the profit in one atomic transaction.

• Example: Buying DAI on Uniswap where it's priced at $0.99 and selling it on SushiSwap where it's $1.01.
• Key Benefit: Enables large-scale arbitrage without requiring the trader's own capital, democratizing access to market inefficiencies.

Used in lending protocols like Aave or Compound to safely change a user's collateral type without triggering liquidation. A flash loan is taken to repay an existing debt, freeing the original collateral, which is then swapped for a new asset and deposited as fresh collateral before the loan is repaid.

• Mechanism: 1) Flash borrow stablecoins. 2) Repay debt to unlock ETH collateral. 3) Swap ETH for wBTC. 4) Deposit wBTC as new collateral. 5) Borrow stablecoins to repay flash loan.
• Risk Mitigation: This atomic process eliminates the liquidation risk present in a manual, multi-step collateral swap.

Flash loans empower liquidators to profit from undercollateralized positions on lending platforms without upfront capital. The loan provides the funds to repay the borrower's debt, claim the discounted collateral as a reward, sell it, and repay the flash loan—all in one transaction.

• Efficiency: Allows any user with gas funds to act as a liquidator, increasing market health.
• Example: A position on MakerDAO becomes undercollateralized; a liquidator uses a flash loan of DAI to cover the debt, receives the collateral (e.g., ETH) at a discount, sells it, and keeps the difference.

A defensive strategy where a user employs a flash loan to close their own undercollateralized position before a third-party liquidator can. This allows the user to avoid liquidation penalties and potentially retain some remaining collateral value.

• Process: The user flash borrows the required stablecoin, repays their own loan in full, reclaims their collateral, sells a portion to repay the flash loan, and keeps the remainder.
• Outcome: The user minimizes losses compared to a forced liquidation, though they still bear transaction costs and market slippage.

A malicious use case where an attacker borrows a massive amount of a governance token via flash loan to temporarily gain voting power in a decentralized autonomous organization (DAO). They use this voting power to pass a malicious proposal (e.g., draining treasury funds) before repaying the loan.

• Famous Example: The 2020 bZx protocol exploit involved using flash loans to manipulate oracle prices.
• Mitigation: Protocols now use time-weighted voting or snapshot voting detached from immediate token balances to prevent such attacks.

Advanced DeFi users employ flash loans to move debt between lending protocols to secure lower interest rates. A user can flash borrow to repay a high-interest loan on one platform and simultaneously take out a new, lower-interest loan on another to repay the flash loan.

• Benefit: Optimizes borrowing costs dynamically.
• Complexity: Requires precise calculation to ensure the arbitrage covers all gas fees and protocol costs, making it viable primarily for large loan sizes.

The defining feature of a flash loan is its atomic execution: the entire sequence of borrowing, executing operations, and repaying must succeed within one transaction block. If any step fails, the entire transaction is reverted, eliminating default risk for the lending protocol. This atomicity is enforced by the Ethereum Virtual Machine (EVM) and similar environments, making flash loans a unique financial primitive.

Flash loans are tools for sophisticated on-chain strategies that require significant, temporary capital. Common uses include:

• Arbitrage: Exploiting price differences for the same asset across decentralized exchanges (DEXs) like Uniswap and SushiSwap.
• Collateral Swaps: Repaying a debt position on one platform (e.g., MakerDAO) to move collateral to another without personal capital.
• Self-Liquidation: Paying down a loan to avoid liquidation penalties at a lower cost than the penalty itself.
• Governance Manipulation: Briefly acquiring voting power for proposals, though this is often mitigated by snapshot mechanisms.

A flash loan is executed via a smart contract call that follows a specific flow. The borrower's contract:

1. Calls the lender's pool (e.g., Aave, dYdX), receiving the borrowed assets.
2. Executes its custom logic (e.g., trades, swaps) using the funds.
3. Repays the loan plus a small fee (e.g., 0.09%) to the pool, all within the same transaction. The lender's contract uses a callback function (like executeOperation) to ensure the repayment is verified before the transaction finalizes.

Several major DeFi protocols pioneered and popularized the flash loan mechanism:

• Aave: The first to formalize the concept with its flashLoan function, becoming the most widely used provider.
• dYdX: Offered early, simple flash loans with zero fees, though it has since deprecated its standalone lending product.
• Uniswap V2: Introduced flash swaps, allowing users to receive any asset and repay with any other asset from the same pool.
• Balancer V2: Also supports flash loans from its managed pools, integrated into its vault architecture.

While secure for lenders due to atomicity, flash loans are a potent attack vector for exploiting protocol vulnerabilities. Attackers can borrow massive sums to temporarily manipulate oracle prices, drain liquidity pools via reentrancy, or execute governance attacks. Notable exploits include the bZx attacks and the Harvest Finance incident. These events highlight that while the loan itself is risk-free for the lender, the borrowed capital can amplify the impact of existing smart contract bugs.

Flash loan fees are typically a small, fixed percentage of the borrowed amount, providing revenue for the lending protocol and liquidity providers. For example, Aave charges 0.09%. The economic viability of a flash loan strategy depends on the gas cost of the complex transaction and the profit margin from the arbitrage or operation. High Ethereum gas prices can render small-amount strategies unprofitable, making flash loans primarily the domain of bots and large-scale operators.

A flash swap is a more generalized version of a flash loan that allows the uncollateralized withdrawal of any ERC-20 token from a liquidity pool, with the option to pay for the withdrawn tokens with a different token. This enables complex, multi-token arbitrage and liquidation strategies within a single transaction.

• Key Difference: Unlike a standard flash loan, which requires you to borrow and repay the same asset, a flash swap allows you to repay with a different asset.
• Primary Use Case: Used heavily in arbitrage between decentralized exchanges (DEXs) and for liquidation in lending protocols where the collateral and debt are different assets.

An atomic transaction is a series of operations that either all succeed or all fail as a single, indivisible unit. This is the fundamental blockchain property that makes flash loans possible and safe for lenders.

• Mechanism: The entire flash loan borrow-use-repay sequence is bundled into one transaction. If the final repayment step fails, the entire transaction is reverted, meaning the initial loan never occurred.
• Critical Importance: Atomicity eliminates lender risk, as the funds are never truly at risk of being lost. It also allows developers to execute complex, conditional logic without upfront capital.

Arbitrage is the practice of buying an asset in one market and simultaneously selling it in another to profit from a price difference. It is the most common and legitimate use case for flash loans.

• Flash Loan Role: Provides the large, upfront capital required to exploit small, fleeting price discrepancies between DEXs (e.g., Uniswap vs. SushiSwap) without the arbitrageur's own funds.
• Market Impact: This activity is essential for market efficiency, as it helps align prices across different trading venues. Profits are made from the price delta, minus the transaction fee and any flash loan fee.

In DeFi lending protocols, liquidation is the process of selling a borrower's undercollateralized position to repay their debt. Flash loans enable highly efficient, capital-efficient liquidations.

• Mechanism: A liquidator uses a flash loan to borrow the stablecoin needed to repay the borrower's debt. In return, they receive the discounted collateral, sell it to repay the flash loan, and keep the difference as profit.
• Benefit: This allows anyone to act as a liquidator without holding significant capital, ensuring the protocol's solvency is maintained by a competitive, decentralized network of actors.

Maximal Extractable Value (MEV) refers to the profit that can be extracted by reordering, including, or censoring transactions within blocks. Flash loans are a primary tool for arbitrage and liquidation bots competing for MEV.

• Connection: Searchers use flash loans to fund large, profitable on-chain opportunities they detect in the mempool (e.g., a large DEX trade that will move prices).
• Impact: This competition drives up transaction fees (gas wars) and is a central topic in blockchain design, leading to solutions like Flashbots to mitigate its negative externalities.

A smart contract vulnerability is a flaw in a contract's code that can be exploited, often resulting in loss of funds. Flash loans are frequently used to magnify the impact of these exploits, though they are not the root cause.

• Common Exploit Pattern: An attacker uses a flash loan to temporarily gain control of a massive amount of capital, which is then used to manipulate oracle prices, drain liquidity pools, or trigger faulty logic in a vulnerable protocol.
• Key Insight: The exploit exists in the target protocol's code; the flash loan is merely the funding mechanism that turns a small theoretical attack into a multi-million dollar loss.