Bitcoin : What is a flash loan? A necessary evil

What is a flash loan?

The flash loan is a novelty specific to decentralized finance, halfway between technical and financial engineering.

This is a instant loan without counterparty risk, who does not ask no guarantee, provided you are reimbursed in a single transaction on Ethereum.

By this process, without capital, it is now possible to borrow without limit in order to find in DeFi applications arbitrage opportunities to generate immediate profit.

This clashes with the over-collateralization needs that have become the norm in the decentralized finance ecosystem to date.

Operation and scope of flash loans

The flash loan or instant loan, therefore allows, in a single transaction, to:

Borrow capital Use this capital to buy an asset on a decentralized exchange platform A Resell this asset at a higher price on a platform B Pay off debt and interest Keep the balance once the terms of the loan are respected.

Note that technically the transaction must carry out action 1 and 4 to be valid. In the event of errors or improper handling, the transaction is canceled and therefore less costly.

This democratizes what was already possible to do if you yourself had a substantial amount of capital.

However, this operation is not within everyone’s reach. This is not as easy as it looks.

Such examples have multiplied in recent months with a double economic situation, a massive influx of fresh capital into DeFi and the multiplication of services with relative security.

As evidenced by Harvest Finance, Akropolis, Eminence, which over the past few months have suffered flash-loan attacks resulting in losses of several million dollars or even tens of millions of dollars.

hack defi flash loan

In addition, in addition to an obvious economic benefit, it is possible with the borrowed capital to carry out other actions such as borrowing a governance token in substantial proportions in order to reverse a vote that may be unfavorable to you. This mishap happened at the end of October during a vote concerning MakerDAO.

The Harvest Finance example

The flash loan to which Harvest Finance was victim is resounding in terms of the volume generated of $ 34 million.

Harvest Finance offers “Vault” type investment products as Yearn. By depositing an asset in it, smart-contracts are responsible for automatically applying an investment strategy to derive a profit measured by an interest rate.

The attacker has several times deposited funds in this Vault, withdrew them subsequently in order to manipulate the prices and finally transformed them via decentralized exchange platforms as detailed in the team’s public post.

The price of the FARM asset specific to this service then automatically collapsed by 60% following the discovery of the attack.

volume uniswap attack harvest finance

Unprecedented volume on October 26 on Uniswap the day of the attack

This results in an abnormally high volume for the Uniswap and Curve platforms generating fees for liquidity providers or holders of tokens giving right to part of the fees.

Flash-Loan: a good test for an application

The Flash-Loan is an innovation.

We can obviously judge any innovation morally and thus praise the good it brings or, on the contrary, regret it with regard to the harm caused.

Nevertheless, the immediate loan is a reality that cannot be denied.

It is, moreover, always easy to accuse this immediate borrowing system to cause losses for users and investors whatever the project, whereas the responsibility rests above all on the developers behind the product and to a lesser extent on the users of the service.

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The risk of using an immature and unaudited service is colossal. The fees associated with their use can be significant but always reflect the risk inherent in the project.

In short, passing the flash-loan test makes it possible to test the robustness of a service and thus separate the wheat from the chaff. It is a necessary evil that makes it possible to reinforce the standards of the Challenge sector, and to improve its resilience little by little through good practices or technical measures to prevent them.

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About the Author : Stanislas Barthelemi

Stanislas is a consultant at Blockchain Partner in charge of DeFi subjects and the site since 2018. He was interested in Bitcoin from 2017 through the political and economic angle (in particular monetary) via the thought of the Austrian school .
All articles by Stanislas Barthelemi.