What Are Flash Loans In DeFi? 

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DeFi powered by blockchain has helped evolve the traditional financial industry. With DeFi you get a permissionless, hassle-free, transparent and decentralized financial ecosystem based on blockchain technology. The use of cryptocurrency has changed the lending and concept of money, as DeFi brings in the alternative of a traditional financial platform.

AAVE, earlier known as ETHLender has innovated traditional money lending into one of the best concepts named flash loans. In traditional money lending or the traditional loan systems, you get a guaranteed loan amount as collateral or the security assets that you give in exchange. For instance, you run a business for which you have to lend money from traditional money lenders. Now when you do so, the money lender requires some type of collateral as an assurance of getting their money back, if you fail to repay. When you repay the amount, you do it by paying the estimated interest along with the capital amount, within a period of months or years. But with flash loans, you can lend amounts instantly without giving any collateral or security assets. Let us now unfold the concept of flash loans in this article.

What are flash loans in DeFi?

Flash Loans are uncollateralized lending powered by decentralized finance protocols. They help borrow any amount or assets without any collateral, depending on returning the liquidity to the protocol within the duration of a block’s transaction.

Flash loans allow you to borrow an unguaranteed amount with an obligation to pay back immediately in the same block transaction. If it is analyzed that the person taking a flash loan will not be able to repay immediately, then the process is reversed as if it never started in the first place. These flash loans are famous on the various DeFi protocols running on the Ethereum blockchain.

It is possible to do flash loans without any coding. You can process flash loans with the help of user interfaces. There are tools that allow end-users to leverage flash loans for instance collateralswap or defisaver. DeFi traders prefer these types of loans for profit generation strategies including collateral swaps and arbitrage.

Flash loan is a unique tool that helps trade via unsecured loans without any intervention of intermediaries. They are executed with the help of smart contracts. Smart contracts govern the transaction while safeguarding the execution of transactions, making them contract compliant. By following the rules mentioned in the smart contract, the flash loans are secure and run in a specified manner.

Let’s now understand the properties of a flash loan in the next section.

What are the properties of a flash loan in DeFi?

Flash loans have unique properties as given below:

Smart contracts

Smart contracts, which are blockchain-based contracts that prohibit fund exchange unless certain criteria are satisfied, are used in flash loans. The borrower must return a flash loan before the transaction ends; else, the smart contract reverses the transaction, making it look as if the loan never happened.

Unsecured loan

Borrowers are commonly required to deposit collateral by lenders in order for them to reclaim their money if the borrower fails on the loan. Unsecured loans, on the other hand, do not demand collateral.

The borrower’s inability to repay the lender’s flash loan is not due to a lack of collateral. It is returned in a unique way. The borrower must return the money promptly rather than providing collateral.

Instant lending

Obtaining and repaying a loan can be a lengthy procedure. Borrowers who are authorized for a loan must repay the amount over a period of months or years. A flash loan, on the other hand, is immediate.

Both the parties must meet the loan’s smart contract simultaneously with the loan’s payout. Before the trade expires, which usually takes a few seconds, the borrower must invoke other smart contracts to make immediate transactions with the loaned cash.

Why should we use flash loans?

Flash loans are permissionless, which means they don’t require anyone’s approval or verification. Because anybody with a computer and a wifi connection can access capital as easily as a bank or professional trader, they have the potential to help democratize the financial system and level the playing field between people and huge organizations.Though most users of flash loans are now very technical, developers investigate methods to incorporate them into user interfaces and apps. Below mentioned are the advantages of flash loans:

Risk-free lending

A borrower of an asset might not be able to repay a standard loan. This is referred to as default risk. However, because the payback is part of the same indivisible transaction as the loan, the nature of a flash loan ensures that it will be repaid. Because the loan is risk-free, everyone with assets is encouraged to lend, putting resources to productive uses that would otherwise go unused.

Increased capital efficiency with zero collateralization

In the conventional banking system, obtaining a loan necessitates the deposit of some form of security. Even most DeFi methods require borrowers to put down collateral that is more than the loan’s value. Obviously, this restricts the majority of financial services. It also restricts the size of a potential opportunity for a borrower. However, because flash loans supposedly remove default risk, no collateral should be necessary to back them up.

Better user experience

On MakerDAO, repaying a collateralized debt position (CDP) is usually a two-step procedure. A user must first get DAI, a stablecoin. The DAI is then used to repay the loan and redeem the collateral. Each step after the first adds complexity and expenses, which compound as transactions get more intricate. Flash loans directly solve this issue by combining many transactions into a single transaction.

How to execute a flash loan using a smart contract on Ethereum?

Below mentioned steps will help you execute a flash loan:

Step 1

Use Remix Setup, which is a browser-based IDE. This will help write, debug and deploy the solidity smart contracts for flash loan execution. Now load up your Remix IDE for the smart contract.

Step 2

The next step is to install a MetaMask. MetaMask is a browser extension that helps us to interface with the Ethereum platform. Download the extension. Create a secure password for your MetaMask. then write down the mnemonic seed phrase.

Step 3

After doing steps 1 and 2, we are ready to write the solidity smart contract now. All the solidity smart contract files are stored in the .sol extension. For flash loan, you will create various files like,

  • FlashLoan.Sol
  • FlashLoanReceiverBase.sol
  • ILendingPoolAddressesProvider.sol
  • IFlashLoanReciever.sol
  • ILendingPool.sol
  • Withdrawable.sol

Step 4

The next step is to deploy the flash loan contract. Open your MetaMask and then set your network to the Kovan Test Network. Then define the dependencies for flash loan smart contracts. Then switch to the Solidity compiler tab and set the compiler to 0.6.6 and then click on Compile FlashLoan.sol.

Step 5

Switch to deploy and run transactions page and provide the address of the Lending Pool. Then click on deploy. This will open the MetaMask. Click on confirm and then you will see a Deployed Contracts button on the side panel.

Step 6

Fund your flash loan from MetaMask and then execute it by going back to your Remix.

How can LeewayHertz help you integrate flash loans into your systems?

Smart contract development

We develop Solidity smart contracts for the execution of flash loans. These smart contracts automate the flash loans and specify their executions terms.

DeFi apps development

We develop decentralized finance applications on a peer-to-peer ecosystem by giving control to the nodes’ consensus and by eliminating a single central intervention for flash loan execution.

Wallet development and integration

We build non-custodial decentralized wallets for flash loan processing. We also integrate MetaMask into your existing wallets or the wallets built by our experts. With our DeFi wallets, you can leverage fast lending and enhanced security.

Maintenance and upgrade

We maintain and upgrade the existing DeFi wallets making them compliant with the current innovations in flash loan executions.

Wrapping Up

Flash loans will have a significant impact on the future of DeFi. The ability to make uncollateralized loans, as well as the usage of smart contracts, are two of the most appealing features of flash loans. As a consequence, they demonstrate a wide range of options for the development of an entirely new financial system. Even if the use cases for flash loan transactions are currently restricted, they have the potential to open up a wide range of new DeFi operations.

For more flash loan-related development, connect with our DeFi experts.

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Author’s Bio

Akash Takyar
Akash Takyar
CEO LeewayHertz
Akash Takyar is the founder and CEO at LeewayHertz. The experience of building over 100+ platforms for startups and enterprises allows Akash to rapidly architect and design solutions that are scalable and beautiful.
Akash's ability to build enterprise-grade technology solutions has attracted over 30 Fortune 500 companies, including Siemens, 3M, P&G and Hershey’s. Akash is an early adopter of new technology, a passionate technology enthusiast, and an investor in AI and IoT startups.

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