There are legitimate reasons why someone would want to utilise a Flash Loan, which would benefit them and the wider DEFI ecosystem. Here’s an example from Aave’s website where a Flash Loan enables the swapping of collateral for a MakerDAO Vault:
In this case, the user holds a collateralised ETH position with MakerDAO but wants to swap that for BAT (Basic Attention Token). A Flash Loan provides an alternative way to achieve this that benefits the user because they don’t have to return the DAI that was originally minted and lose out on the yield it is generating.
The user can then swap ETH for different collateral such as BAT, presumably because they feel that has greater upside, and with the BAT vault opened, can return the original loan within the space of one block and pay the Aave fee for the Flash Loan of 0.09% of the amount borrowed.
There are far more complicated Flash Loan applications, but all will centre on some kind of arbitrage opportunity. So the legitimate benefits of Flash Loans can be summarised as:
- Improving the efficiency of DEFI
- Generating revenue for lending providers in Flash Loan fees
- Providing a revenue stream for those taking out a Flash Loan
So what’s the downside to Flash Loans? The problem is that they can also be used in ways where the benefits are skewed dramatically to whoever is taking out the Flash Loan, and very much to the detriment of lending pools and token issuers.
No surprise that there has been a huge increase in Flash Loan Exploits where attackers use increasingly complex chains of actions combining the manipulation of illiquid tokens and flaws within Smart Contracts.
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