Flash Loans: What Are They and How Do They Work?

Flash loans

Flash loans. If you’re keeping an eye on news in the crypto space, you’ve probably heard plenty about them in recent weeks.

And of course, there’s been headlines featuring flash loans as the lead players in recent hacks and exploits such as those on PancakeBunny and Bogged Finance, along with plenty of others.

But even though flash loans are  often-discussed, many still don’t understand what a flash loan is, how they work andwhat can be done with them — we hope this helps.

What are flash loans?

We’ll start with the basics — what is a flash loan exactly? 

Well, as its name would imply, it’s a particular type of loan, which for our purposes will be defined as borrowing money against collateral that must eventually be repaid. That collateral must typically be worth more than the loan itself, so if you 

What changes here is the idea of collateral, along with the repayment rate. With a flash loan, the person taking out the loan also repays it in the same transaction. While it may seem pointless to borrow a large sum of money and immediately pay it back, there is a method to this madness. 

Flash loans allow the recipients to take loans without providing collateral, meaning that borrowers can take out a much larger amount of money than they would be able to borrow with a traditional loan. Recipients can then use that loan to profit elsewhere via arbitrage and by providing liquidity.

What can you do with them?

As we mentioned earlier, flashloans allow borrowers to profit by taking a large loan, use it to profit off arbitrage or provide liquidity, and immediately return the loan.

For example, let’s say you used a flash loan to buy a large amount of ETH for roughly $100 on Exchange A. But on Exchange B, you can sell the same amount of ETH for $101, allowing you to extract a profit off the transaction (if a small one in this example.) With flash loans, you could borrow far more money, for example, $1 million, and perform a similar transaction, profiting far more than you could with a traditional loan. 

You could also use the loan to temporarily provide a large amount of liquidity for a given pool, extracting the reward for that liquidity and repaying the loan, once again making a tidy profit in the process.

Transactions, not exploits

One last thing on flash loans before we go. Crucially, while their reputations may suggest otherwise, Flipside Crypto’s Angelo Di Donato says it’s important to point out that flash loans “are not hacks or exploits.” 

Rather, they are transactions that are allowed by the code of various protocols and platforms. In the same fashion, “flash loan exploits” are typically just a combination of flash loans and price manipulation, rather than a true exploit on the platform’s code.

If you want to see how they, and other transaction types, impact the protocols and ecosystems they take place on, you can join our community on Discord to chat with other crypto enthusiasts and get started with our bounty program!

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