Flash Loan Technology Explained: Part 1

Introduction

Bear markets serve as a crucible, testing which core DeFi sectors can thrive across cycles and which face challenges. SharkTeam's DeFi Security series dives deep into these discussions, with this second lesson focusing on Flash Loan Technology.

This comprehensive guide is divided into three parts. Part 1 covers:

Principles and use cases of flash loans.
Smart contract implementation and risk mitigation.
Analysis of prominent flash loan protocols.

1. Principles of Flash Loans

1.1 Concept Overview

A flash loan is an uncollateralized loan borrowed and repaid within an extremely short timeframe (a single blockchain transaction). Pioneered by Marble Protocol and popularized by Aave, dYdX, and Uniswap, it’s a cornerstone of DeFi innovation.

1.2 How It Works

Flash loans leverage atomic transactions in smart contracts:

Funds are borrowed and repaid in the same transaction.
If repayment fails, the entire transaction reverts, eliminating lender risk.
Borrowers pay a small fee (e.g., 0.09% on Aave) for the service.

Example Flow:

Borrow 100,000 DAI via Aave’s flash loan.
Use DAI for arbitrage (e.g., DAI/USDC swaps across exchanges).
Repay 100,000 DAI + fees before the transaction ends.

👉 Explore Aave’s flash loan contracts

1.3 Key Distinctions: Flash Loans vs. Flash Swaps

| Feature | Flash Loan | Flash Swap |
|------------------|--------------------------------|--------------------------------|
| Repayment | Same asset (+fee) | Any asset (flexible) |
| Cost | Fixed (e.g., 0.09%) | Exchange fee only |
| Complexity | Requires 3+ operations | Fewer steps |

2. Use Cases

2.1 Arbitrage

Scenario: Exploit price differences between DEXs.
Steps:

Borrow 100,000 DAI via flash loan.
Swap DAI → USDC on Uniswap (1:1.01 rate).
Swap USDC → DAI on Curve (1:1).
Repay 100,090 DAI (loan + fee), keeping 920 DAI profit.

Risks: Network fees, slippage, and frontrunning bots.

2.2 Collateral Swaps

Goal: Shift ETH collateral to BAT on Compound.
Steps:

Flash-borrow DAI to repay existing loan.
Withdraw ETH → Swap for BAT → Re-deposit as new collateral.
Re-borrow DAI to repay flash loan.

2.3 Self-Liquidation

Avoid liquidation fees by:

Borrowing owed DAI via flash loan.
Repaying loan to free ETH collateral.
Selling partial ETH to repay flash loan + fees.

FAQ Section

Q1: Are flash loans risky for borrowers?
A: Only if the transaction fails (e.g., arbitrage isn’t profitable), but no loss occurs since it reverts.

Q2: Which protocols offer flash loans?
A: Aave, dYdX, and Uniswap (via flash swaps).

Q3: What’s the minimum transaction size?
A: Limited only by gas fees and blockchain capacity.

👉 More on DeFi strategies

Conclusion

Flash loans democratize access to capital in DeFi, enabling advanced strategies like arbitrage and collateral management. Part 2 will delve into smart contract risks and safeguards.

Keywords: flash loans, DeFi, arbitrage, Aave, dYdX, Uniswap, collateral swaps, atomic transactions


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