DeFi (Decentralized Finance) ecosystem is innovating continuously and showing what things can be enabled when you have programmable money. Flash loans are the latest addition in this ecosystem.
What is a Flash Loan?
A loan that got borrow and repaid in a single Ethereum transaction called flash loan. Hence you don’t need any collateral for flash loans. Here are the properties of a Flash loan:
- Borrow and repaid in a single transaction
- No collateral required
- The borrower needs to return the original borrowed amount + a small fee (0.09% currently)
- The transaction needs to be completed successfully otherwise everything will be reverted, and you need to pay the only Gas fee (Ether needs to execute the transaction)
How does a Flash Loan work?
Flash Loans are introduced by the Aave project, which a borrowing and lending protocol built on Ethereum.
Aave protocol enables typical collateralized loans. Anyone can borrow and lend Ethereum and other tokens using Aave protocol. When you lend your tokens, you earn based on the current interest rate. This is how the protocol gets its liquidity. These are regular collateralized loans and can be borrowed for an extended period.
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In the case of Flash loans, anyone can borrow this liquidity, use it with other protocols (Arbitrage, swap, trade, borrow or lend on different protocols, etc.. ), and repay in a single transaction.
The borrower needs to return the original amount with a small fee; otherwise, the whole transaction will be reverted and will not affect.
Benefits of Flash Loan
Flash Loans are an essential innovation in a decentralized finance ecosystem. One of the huge benefits of flash loans is that now people don’t need collateral to access insane amount liquidity. So everyone can become a ‘whale’ now.
Use cases of Flash Loan
There are hundreds of use cases of Flash loan depends on how big a nerd you are. Flash loans are getting integrated throughout the DeFi ecosystem. Let’s discuss some of the use cases.
Arbitrage
Taking advantage of price differences between markets to make a profit is called Arbitrage. Using Flash loan, now anyone can utilize a massive amount of liquidity to arbitrage between multiple decentralized exchanges. ArbitrageDao is a project, which is utilizing Aave’s flash loan for this purpose.
Debt Refinance
Let’s say you have taken debt from compound protocol at a 10% interest rate. But another protocol offers debt at 5%. In this case, you can refinance your debt at 5% without any collateral. Here are the steps.
- Borrow the flash loan from Aave protocol
- Pay your debt on the compound protocol
- Borrow on 2nd protocol at 5% protocol
- Payback your flash loan
Wrapping Up…
Flash loans are an essential part of DeFi composability and increase the usability of the overall ecosystem. Such innovation can not exist in the traditional finance world.
DeFi is showing how an efficient financial ecosystem looks like when you remove intermediaries and have programmable money. To learn more about Flash loans, checkout Aave’s discord group.
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