What are instant loans (flash loans) and how to make money on them

Imagine you have a great opportunity to make money in the crypto market, but you need a lot of money here and now to make a profit. Instant loans in cryptocurrency are the solution to this and many other schemes. Let’s find out how flash loans work and how to make money from them.

In this article:

• What are Flash Loans in DeFi
  • How flash loans came to be
  • Flash loans application schemes
  • Where to get this loan
• Auxiliary platforms for working with flash loans
• Flash loan scams

What are Flash Loans in DeFi

Instant loans, or flash loans, are a scheme by which digital assets can be borrowed without collateral. The main condition of the deal is that the user has to repay the loan in the same transaction block. So it only takes a few seconds from the time the loan is processed to the time it is repaid.

The demand for high-speed transactions implies their automation. Flash credits are available in a number of decentralized finance (DeFi) segment protocols, which are based on smart contracts. 

Important! You can borrow millions of dollars through flash loans. The origination fee can be as low as a few tenths of a percent.

It is impossible to take a flash loan and disappear. The fact is that smart contracts prescribe the requirements for transactions in advance. For example, if the user fails to use the amount borrowed for its intended purpose and promptly repay the debt, the loan is instantly returned to the platform.

How flash loans came to be

The creators of the flash loan scheme are considered to be the Marble Protocol project team.  Tools for collateral-free loans on the Ethereum blockchain, which the developers called a “smart bank” based on smart contracts, were presented to the public in 2019.

The first really popular instant loan scheme was offered by Aave, a lending platform, in early 2020.  First, developers of third-party DeFi-protocols got access to flash loans. The platform supplied funds for unsecured loans on Aave from its own liquidity pools.

By the end of 2020, the platform’s instant loans had reached $2 billion. By the second half of 2021, the number had more than doubled.

Amid the active growth of commissions in the Ethereum network, market participants turned their attention to the possibility of applying schemes with flash loans to reduce transaction costs. They also found options for earning through flash loans. The benefits of the scheme contributed to the rapid growth of its popularity.

Six months after Aave flash loans appeared, the technology was borrowed by the decentralized cryptocurrency exchange dYdX. Later, the scheme, as well as its analogues, became available to users of many other DeFi-platforms. For example, flash swaps of the decentralized cryptocurrency exchange Uniswap, which were offered in May 2021, became an alternative to flash loans.

Today, instant loans are available on many popular blockchains besides Ethereum. Among others, the functionality appeared on Binance Smart Chain, Solana, Avalanche, Polygon and Fantom.

Flash Loan application schemes

There are several schemes for applying flash credits. The most popular one is for making money on cryptocurrency arbitrage. Let’s consider it in more detail.

The process involves earning on the price difference of the same asset on different platforms.

Here’s what the process of arbitrage trading with flash loans looks like:

• It is needed to find a suitable offer to make money on arbitrage.
• After that, it is needed to issue a flash loan, with which the user can buy the asset on the platform where it trades at a lower price.
• The next step is to sell the same amount of assets on the platform where the coins are priced higher.
• After the transactions, it is necessary to repay the loan and pay the interest for using the cryptocurrency.

As a result, the user receives income in the form of the difference between the purchase and sale price of digital assets.

Flash loans can also be used in a number of other schemes, including the following:

• To liquidate debt positions. The scheme helps avoid penalties from the lending platforms in case the value of the collateral becomes lower than the value of the debt due to price changes in the market. Thus, with the help of flash loans, the collateral deposit can be quickly released.
• To replace loan collateral. In this case, flash loans help to avoid penalties if the value of the collateral asset becomes less than the value of the debt. The user can promptly release the former collateral deposit and replace it with another one.

Flash loans can also be used, for example, to refinance loans. The scheme involves promptly repaying a loan on one platform at the expense of a flash loan and then re-lending on another platform at a lower interest rate.

Where to get a this loan

The already mentioned Aave and dYdX, which run on the Ethereum blockchain, are not the only platforms where you can get a flash loan. They are also available on a number of other platforms.

For example, in the Binance Smart Chain network, the developers of the C.R.E.A.M. Finance project offered their version of loans. On the Polygon blockchain – UniLend Finance.

Auxiliary platforms for working with flash loans

The digital asset market also offers platforms that make instant loans easier to work with. Among them are the following:

CollateralSwap. The service will be useful for those who need to quickly replace the collateral for a loan or liquidate a debt position.

DeFi Saver. The platform helps to automate the management of positions in the decentralized finance market. In particular, with DeFi Saver it is possible to control Aave and dYdX flash loans.

Furucombo. You can use the program to create your own DeFi earning strategies, taking into account the possibilities of flash loans.

Flash loan scams

Unfortunately for the developers of the technology, flash loans have become an effective source of funding for fraudulent attacks. Here are a few examples of asset thefts that attackers carried out with the help of flash loans:

• The theft of $6 million from the Value DeFi protocol.
• Attack on Harvest Finance.
• Withdrawal of $8 million from Warp Finance’s DeFi protocol.
• Attack on MakerDAO.

It is possible that in the future, participants in the digital asset market will repeatedly encounter news about the theft of cryptocurrencies, in which scammers used schemes with flash loans.