Flash loans provide instant money to crypto speculators
(Bloomberg) – Money for nothing. This is what a rapidly growing line of financial products called flash loans is promising crypto devotees.
This practice is the latest attempt by the digital asset crowd to rewrite the rules of financial transactions, removing many of the current guardians of the image in research to achieve what they call decentralized finance, or DeFi. As with most crypto things, the promise is great, with the dangers often just as well.
Here’s how flash loans generally work: Borrowers can take unsecured loans from lenders and use the proceeds for whatever they want. One of the most popular uses is to arbitrate coin price differentials on different exchanges. The key is that the loan, transaction, and repayment are grouped together in the same block of transactions being processed on the Ethereum digital ledger and executed simultaneously.
The time between borrowing and paying off a loan usually takes a few seconds. In the example, the transaction is submitted to the network, temporarily lending the funds to the borrower. If the transaction is not profitable, the borrower can reject the transaction, which means the lender gets their funds back either way. When it comes to blockchain, the lender has always had the funds. The user pays the blockchain processing fee.
“In a way, flash loans make everyone a whale,” said Nikola Jankovic, community manager at flash loan provider DeFi Saver, referring to the crypto industry’s nickname for them. large investors who are often able to move the markets on their own.
While there is no precise figure on the current size of the market, one of the biggest players, Aave, said it processed $ 2 billion in flash loans last year after it started in January. Several competitors offer similar services.
“I can see them getting big,” said Aaron Brown, a crypto investor and Bloomberg Opinion columnist. “The same conceptually exists in the traditional financial system. I can buy and sell things for several times my total fortune over the course of a day, as long as at the end of the day everything ends in a positive balance. It’s just with crypto that there is no settlement time, so to do the same you need flash loans.
Stani Kulechov, CEO of London-based Aave, expects all cryptocurrency networks to eventually offer flash loans.
“Ultimately, flash loans are going to be everywhere,” Kulechov said. The biggest flash loan Aave has processed to date was around $ 200 million, he said. Aave has approximately $ 3.9 billion in financing capacity, according to data tracker DeFi Pulse.
This democratization of finance has the potential to make the crypto market more efficient.
“They have the potential to dramatically increase market efficiency as there are no longer high investment costs to exploit arbitrage opportunities,” said Jack Purdy, analyst at researcher Messari. “When anyone in the world can execute these transactions in disparate markets, it helps crypto prices converge, tighten spreads, and reduce inefficiencies.”
But it also has drawbacks, which are unlikely to be ignored by regulators. People have already used flash loan attacks to manipulate coin prices and steal millions of funds, Brown said.
“Flash loans will continue to be associated with manipulation and hacking,” he said. “But they’re not really essential to these things, they just mean manipulators and hackers don’t need capital anymore.”
And because they happen so quickly, manipulators and hackers can probably get away with the loot before anyone notices them. They were gone in a flash.
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