DeFi Flash Loan Explained – Unsecured Crypto Loans

One of the most recent solutions from Challenge and as such, a step towards the adoption of Blockchain and cryptocurrency is DeFi Loan. You would not have imagined a loan without a third party before the invention of DeFi. Therefore, DeFi allows you to do that. Hence, DeFi not only provides decentralized secured loan, but also unsecured loan offer called flash loan.

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In order to make the distinction, this article informs you of the different DeFi loan offers; secured and unsecured loans (flash loans). He should be able to tell you the merits and, of course, the downsides, if any, while also citing a few use cases of DeFi flash loan.

Secured and unsecured loans

You have seen that loans are not unique to the traditional bank. At the same time, you can get loans for your business or project through a decentralized application. However, don’t be discouraged if you don’t have collateral or equity to borrow, as DeFi offers unsecured alternatives.

In the meantime, if you’ve ever needed to borrow and need to make deposits of a physical or digital asset, these are the collateral. That said, collateral is the deposit or stake you made to borrow. On the contrary, when you may not need to put down or deposit, you are looking for unsecured or unsecured loans.

Nevertheless, it would not be possible without the success of Aave on July 20, which introduced a new feature called Credit Delegation. In a Tweeter, CEO, Stan announced the new feature, Credit Delegation.

The feature provides peer-to-peer loans without formal collateral requirement using a decentralized application. Therefore, today, crypto-asset users can apply for unsecured loans.

Flash loans allow you to borrow without giving up any collateral.

However, just as this is a breakthrough, there could be implications for flash loans regardless.

How the flash loan works

Flash loans can seem like magic. However, it’s all about tapping the smart contract to get a loan, spending the same block, and paying back when the deal is successful. Meanwhile, the smart contract revokes the transaction when it is unsuccessful.

This way you don’t need any collateral as it is in the same block and it is self-executing. Therefore, all you need to do is calculate your next loan need, use the loan, and then sign a smart contract that will help you get a flash loan.

Unlike secured loans which may not have certain conditions, flash loans are dependent on use, timing, and other factors. The requirements include this;

  • Loans must be repaid in a single transaction.
  • Loans must be returned along with additional es
  • The transaction must be successful for the loan to be successful. Otherwise, the smart contract will restore it.
  • Loans are short term, say a few minutes.
  • The loans are borrowed for the specific purpose detailed in the smart contract. It is therefore a locked use.

How to get a flash loan

Since flash loans are for exact use, unlike value-locked secured loans, defining credit usage is one of the first steps in getting a zero secured loan. After determining why you need the loan, your next approach is to locate a lender through a peer to peer platform.

Therefore, a loan offer occurs when a borrower accepts codified agreements called smart contracts between the lender. Instantly, the borrower goes to complete the transaction that required the borrower. However, the borrower must be a smart arbiter to win trades within seconds.

Meanwhile, for the safety of the lender’s fund, if the transaction is not successful, the smart contract automatically returns the borrowed funds.

Platforms offering flash loans (crypto loans without collateral)

The first setting up of a flash loan is done by Aave, an open source and non-depository protocol allowing the creation of a money market. The platform executes flash loans through a new feature called Credit Delegation. However, it’s worth noting that before no, there was nothing called a flash loan, and since the breakthrough of the Aave others may be working towards achieving the same.

Meanwhile, the recent flash loan attack could be a hindrance for others who are considering getting started. Therefore, at the time of writing, Aave is the only platform that allows DeFi flash lending.

Use case

Although flash loans are a relatively new concept, their use case is growing rapidly. However, whatever the use case, it must be predefined and codified on the smart contract before obtaining a loan. That said, here are some popular use cases of DeFi flash loans;

Assuming a trader saw the need to manipulate the market, what the individual wants to do is wash them out. While centralized exchanges allow you little or no assets to wash out the market, you need to have real assets to do so. However, a smart trader can manipulate the market with a flash loan.

For example, a trader may want to manipulate XRP priced at $ 0.2. It will have a huge asset that will pump up and lower the price. However, this cannot happen quickly in a DEX. Therefore, the individual can use a unsecured loan to accomplish the mission.

Simultaneously, if he obtained a crypto loan without warranty let’s say 50 ETH, the individual can successfully manipulate the price and still pay off the loan while getting the profit from the pumped market.

Traders often miss opportunities to take advantage of price differentials between platforms. However, it could be a lack of funding. While some sophisticated traders opt for secured loans, others may not think about it because there are no assets to put into play. From then on, flash lending becomes an option.

Flash loan allows a trader to take advantage of market dynamics without betting.

For example, a trader who discovers that an assistant in exchange Said 10,000 USD and the same asset is 10,700 USD in exchange B. What smart traders do is get a loan to buy the short ad respectively on the exchanges. Therefore, if the trader did not have such money, he could borrow a zero collateral loan to make a profit of $ 700 by simply buying and selling on exchange A and B, respectively.

Refinancing loans

Maybe you’ve borrowed money from one of the DeFi lending platforms, for example KittieFight, and found out that Aave offers a flash loan. What comes to your mind is getting the loan from Aave to pay off your KittieFight loan.

Therefore, after calculating your loans, you head to the Aave lending platform to sign the smart contract. So in seconds, you could clear your secured loan at KittieFight while coming back to Aave to pay off your flash loan. However, when the loan payment fails, the smart contract you had with Aave fails. Therefore, the loan will be withheld.

Limits and perspectives

Besides having a short transaction duration, you are limited to transacting in a single lock if you get a flash loan, there are other limitations of the flash loan. However, since there are downsides, there are also prospects.

Hence, here are the disadvantages of a flash loan;

Usually, a regular lender may not consider issuing a flash loan. However, such a lender maintains the prices of the loaned assets, in the same way as the central banks rate indexed to assets in circulation. Therefore, Joseph Delong in a tweet countered that the rich are manipulating the market:

In addition, whenever flash loans occur, profit would be taken from the chain of transactions, thus adjusting market rates to generate profit.

Nonetheless, there could be a normalization of rates to curb possible inflation and deflation between lenders and parties.

As you may have seen, an arbitrage trade may not need collateral to take advantage of the market advantages; hence, it is normal for traders to be on the lookout for vulnerabilities to take out as many flash loans as possible. The very recent lightning attack justifies the claim.

February 14 and 18, two consecutive attacks occurred which sent a mixed signal to the entire DeFi space. During the flash loan, Bzx saw $ 954,000 siphoned off. However, people argue that this is not an attack but a deliberate executable transaction. Either way, the process has indicated that there is a bug that when exploited could result in loss of funds.

Nonetheless, it does open up ways for developers to prepare to find bugs and build more secure apps.

Conclusion

The traditional ideology is that it takes money to make money. However, the DeFi flash loan proved otherwise. Therefore, traders and market makers can buy and sell without the need for collateral. In the meantime, the parties should endeavor to play the turn of the contract. And on the other hand, developers need to find a bug and build secure apps to protect the platforms.

Disclaimer
The content presented may include the personal opinion of the author and is subject to market conditions. Do your market research before investing in cryptocurrencies. The author or publication assumes no responsibility for your personal financial loss.


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