The development of decentralized finance (DeFi) is disrupting some traditional finance concepts. One such is the creation of flash loans. Gone are those days when users need to provide collateral to take loans. With flash loans, you do not need collateral before you access liquidities.
Sounds exciting right? And you must be wondering how safe this type of loan is. Don’t worry; this article will cover flash loans, how they work, and platforms where you can take them. So read on.
WHAT ARE FLASH LOANS?
Flash loan is a new concept created by the advent of decentralized finance. It is a type that allows users to borrow assets without the need for collateral. The loan is paid back immediately with the same blockchain transaction block. The entire process of lending assets, returning, plus covering loans fee can be as fast as 15 seconds.
Flash loans are low-risk options for borrowers and lenders. They served as an easy and quick way to provide and gain access to liquidity. Since the flash loan is a concept of decentralized finance, it does not require intermediaries. Instead, it uses smart contracts to run the entire loan process.
HOW DO FLASH LOANS WORK?
In the case of traditional finance – where borrowers need to provide collateral before borrowing funds. If they default, the lender can cover the loss using the borrower’s collateral. Since flash loans do not require collateral, how do they prevent lenders from inherent loss?
It is effortless. It is all thanks to the dynamic nature of blockchain and the permissionless nature of smart contract applications. The smart contracts are programmed to allow the lender and borrower to interact within a single node. Such that the lender provides on-chain liquidity, and the borrower comes to the platform to borrow them.
The borrower returns the borrowed asset with the agreed interest within the transaction. If they default, the entire transaction will revert, and the original asset will go back to the lender with no significant loss.
After the loan is approved, the borrower can use the borrowed funds to execute their desired trades or conduct other financial operations on the DeFi platforms, such as swapping tokens or purchasing assets.
What are the potential benefits of flash loans?
Flash loans can provide hundreds of millions of dollars of liquidity. This provides users with unique opportunities for arbitrage, collateral swapping, liquidation, and leveraging ability. The most common use case of flash loans is for arbitrage purposes. By exploiting differences in the prices of an asset on different platforms, arbitrageurs can make fast profits.
For instance, if a token is sold for $5 on Exchange A and $8 on Exchange B. Users can take flash loans, purchase the token on Exchange A, and sell them on Exchange B. As a result they can make a profit of $3 and pay back their loan.
Another benefit of flash loans is for collateral swaps. Collateral swap allows users to close their previous loan position with borrowed assets and open a new one with a different asset. For instance, if a user uses Aave as collateral on one platform, they can take up a flash loan on another platform to repay their loan so that they can withdraw their Aave.
Platform where users can get Flash loans
There are a lot of DeFi platforms where users can obtain flash loans. But here are Some of the top place that where users with flash loans;
- Aave: According to data from Aavewatch, Aave since its inception, has lent users over $300 million in flash loans. It is one of the most popular DeFi platforms which offers Ethereum (ETH), stablecoins, and other ERC-20 tokens as flash loans.
- Compound Finance: Compound is another popular DeFi platform that functions as a lending and borrowing platform, allowing lenders to earn interest on their assets.
- bZx: bZx is a decentralized margin trading platform that allows users to trade with leverage. The platform also offers flash loans on cryptocurrencies.
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Source: https://www.thecoinrepublic.com/2023/07/29/flash-loans-and-their-working-platforms/