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- Flash Loan is a standard for DeFi platform to provide over-collateralized loans, where debtors deposit more in assets than they are withdrawing.
- Flash loans are paid back within the similar transaction that they are taken out, where smart contracts are utilized to conduct successive transactions resulting with the loanee eventually paying back the loan.
- Flash loans are atomic, which means they can only be processed if all involved transactions are executed.
Why Are Flash Loans Used?
Basically, Flash Loans have three core purposes, collateral swapping, self-liquidation, and trading arbitrage.
Various exchanges might charge different prices, from particular assets, opening the door for selling as well as acquiring similar assets on various exchanges for profitability, the mechanism is known as trading arbitrage. It can be performed manually, doing so generally does not yield too much profit.
Shifting the base collateral utilized in the DeFi loans can be annoying and time-consuming, particularly for the ones who categorize their virtual assets. Flash loans can be utilized to swiftly pay off loans to free the locked assets, then use those assets for swapping.
If a conventional DeFi loan base collateral reduces in value significantly, it will be liquidated. Meaning, collateralized assets will be traded at a discount for repayment, generating a loss for the debtor. Flash loans can be utilized to self-liquidate, entirely finishing off the loan, and folks can withdraw the assets put as collateral without any loss.
What Are The Actual Threats of Flash Loans?
As flash loans are atomic, they still possess some risks. They incur network gas fees anyway, no matter if they succeed or not, exposing loanees to front running.
The majority of flash loans utilize the ETH network, as it was the initial prime DeFi-supportive network to attain mass acceptance. With highly escalated Ethereum gas fees, front-running has become a prime issue for the ones pursuing flash loans.
Another risk of utilizing Ethereum for flash loans is the reentrancy attacks, where hackers can withdraw all the money held by a smart contract. This is conducted through an external smart contract capable of withdrawing funds on multiple occasions before confirmation of withdrawal balance.
The utilization of Ethereum smart contracts is distinctly weak to reentrancy hacks because of Ethereum’s Solidity programming language.
How Can We Avoid Flash Loan Threats
If weakness regarding reentrancy is discovered inside smart contracts of well-liked DeFi platforms based on Ethereum, flash loaners can be hit by the loss of millions. Several folks are pursuing DeFi solutions outside the network of Ethereum. An alternative that is gaining traction is White Whale, an initial crypto project to provide flash loans UST arbitrage inside the Terra network.
Terra Flash loans are much safer than the ones on Ethereum. This is due to the development of Terra utilizing Cosmos, which fuels numerous other well-liked projects such as Binance Chain.
Cosmos smart contract engine (CosmWarm) doesn’t enable calls to outside, smart contracts, and smart contract language of Terra is much ahead in forgiving than Ethereum. Making it White Whale immune to reentrancy hacks.
Frontrunning is a threat that cannot be escaped, the best one can do is to lower its likelihood and the harm it inflicts. The majority of these attacks are conducted by bots on Ethereum, which benefits from ETH’s volatile and escalated gas prices. A shift to a network, with reduced and steady network fees, can massively descend frontrunning.