Hi @Samuel94 nice summary, I enjoyed reading your summary, very interesting to learn about flash loans. I Just have few questions, do you think that the fees or interest paid and received in connection with flash loans transaction taxable?
Secondly, since flash loans does not require any collateral, it’s possible to borrow millions of dollars’ worth of ETH or do you think there is a limit?
Thank you @Henry for your comment.
A country operating or enforcing digital taxation will be able to charge tax on the interest, ofcourse in accordance with the tax law of the country where the protocol is located or registered.
The borrowing is without a limit. However, note that the Loan is usually repaid before the completion of the transaction otherwise,it will be reversed by smart contract. There will only be a limit where the protocol does not have the required ETH sort to be borrowed.
Nice summary @Samuel94 .
I’m curious about the following questions concerning flash loan:
Does the volume and liquidity of a flash loan matter? Why, if so?
Can you arbitrage cryptocurrency manually between DEXs (Decentralized exchangers) ? How, if so?
Hi @Cashkid18, even though the questions are not very clear like @Samuel94 had pointed out, I will throw some light on them as I understand.
I will give a response on this on the assumption that Volume here refers to the amount of funds available for arbitrage. I will again assume that Liquidity is the ease of swapping tokens due to the availability of the tokens in the liquidity pools of the protocols. Volume and Liquidity are essential ingredients in arbitraging.
If the intent of a flash loan borrower is to arbitrage, the higher the amount of flash loan they can get, the more their profit yield. The lesser the volume, the lower the profit yield too. So, we can therefore say that the Volume of a flash loan is directly proportional to its arbitrage profit.
Coming to Liquidity, the effect of lack of liquidity in arbitraging using flash loans would be slippage. Slippage would most definitely cause a buyer, for example, to buy at a higher price than they intended, thus incurring some losses. If the flash loan smart contract perceives this kind of scenario, it would revert the transaction, hence leading to an unsuccessful flash loan.
I will also assume that the question here is, “Can one arbitrage cryptocurrencies manually using flash loans”. If this assumption is correct, then I will say no. Flash loans are run by smart contracts and happen in a very short time. So, there is no way manual trading between decentralized exchanges can make this effective.
However one can arbitrage cryptocurrencies on DEXs by connecting one’s wallet to a DApp and using the swap function on the application to execute a buy or sell position.
I hope this helps.
good to know your question was given an accurate answer. just to elaborate, could you share your insight on the response ?
Thanks for sharing this fascinating summary with us @Samuel94
It is very evident that flash loans are essential in determining the direction of DeFi. Flash loans’ two main selling points are the availability of uncollateralized loans and the usage of smart contracts. They thus demonstrate a variety of potential paths for the development of an entirely new financial system, but I’m curious what will happen if the borrower decides not to repay the loan.
Thank you @Idara_Effiong your comment. The term flash loan signifies that the loan only last for a shory period, like 13minutes or thereabout. If the borrower cannot repay within the stipulated time, smart Contract will revert the money back to flash loan protocol.
Flashloan is a function of blockchain technology that stops money from moving from one account to another until specific conditions are met. The smart contract rules make sure that the borrower repays the loan before the transaction expires when a flash loan has been given.With the help of an intuitive user interface, users of the new DeFi tool Flashloans may arrange and execute trades backed by Flash loans.
WHAT IS FLASH LOAN ARBITRAGE 
Some people get confused when they hear flashloan arbitrage, but this is actually easy to understand. A flashloan arbitrage can be easily understood.
Getting a crypto flash loan is a means to secure quick finance for such actions because arbitrage trading relies on spending a significant amount of traders’ capital to generate money. To accomplish this, you take out a flash loan and utilize the money to purchase a cheaper asset on an exchange. Then you sell it on a more expensive exchange.
Trading that takes advantage of the minute price fluctuations between identical assets on two or more markets is known as arbitrage. In order to profit on the price discrepancy, the arbitrage trader purchases the asset on one market and simultaneously sells it on another market. According to flashloan medium
“By using a flash loan traders can borrow a large sum of money to execute an arbitrage trade on two decentralized exchanges. By combining an instant loan with an arbitrage trading strategy, traders can increase their earning potential.”
There are also arbitrage bots and they can be used in arbitrage Trading, I researched one and I got to see an arbitrage bot on Upwork arbitrage bot (Upwork)
Important Flash Loan Features
Smart Contracts:
Smart contracts make guarantee that every process is completed in a single transaction. As an illustration, if you do not return the funds inside a transaction, the lending procedure will be reversed. This procedure also lowers the risk for lenders and keeps the loan secure.
Unsecured Credit:
This implies that you can obtain it without putting up any kind of deposit, collateral, or assets. A credit check is not also required.
Real-time transactions:
It is accustomed to a system of borrowing money, using it for a while, and then returning it within a predetermined time frame. Flash loans are not the same as this. When you receive a flash loan, you must use smart contracts to carry out nearly immediate transactions and pay it back before the single block transaction expires. Usually, everything happens in a split second.
About Flash loan Attacks
The first flash loan attack happened in 2020 when a borrower used the DeFi lending protocol dYdX to take out a flash loan in ETH. The loan was subsequently divided in two and delivered to the lending platforms Fulcrum and Compound.
Read more:
A flash loan attack is a misuse of a platform’s smart contract security in which an attacker typically borrows large sums of money without putting up any security. They then influence the price of a cryptocurrency asset on one exchange before selling it as soon as possible on another.
The strike is quick, and the assailant repeats the attack several times before concluding and vanishing into thin air.
Tools for Detecting Flash Loan Attacks
The issue of flash loan security is addressed by some platforms. OpenZeppelin is a prime example of such a platform. The platform introduced OpenZeppelin Defender, which supports developers in neutralizing attacks by assisting in the detection of suspicious activity and smart contract attacks.
How to prevent a flashloan attack
Implementation of DeFi security platforms
Decentralized pricing oracles
Thank you @ Never-in-trenches for contributing to this body of knowledge and discussion. You suggested a decentralised oracle pricing as a means to stop flash loan attack? Can Chainlink fill in this void?
In this paper I am going to give a better understanding of what flash loan is, its application in defi ecosystem, and negative impact, but let me quickly say that the way people view and use cryptocurrencies has changed a lot since the development of decentralized finance (DeFi), especially with independent financial platforms offering different types of crypto lending, which in turn provides a lot of value to both borrowers and lenders.
One such loan type that has surged in popularity in the DeFi ecosystem is the flash loan, as it allows borrowers to benefit from arbitrage opportunities quickly. It provides the borrowed funds to purchase a crypto asset, sell it, pay back the loan and make a profit.
What Is Flash Loan
To understand what flash loan is and its impacts;
Can Flash Loan Be Possible?
Some people have asked whether flash loan can be possible. Yes, it is possible. Using a platform’s smart contract, the whole lending and returning process occurs within a single transaction on the blockchain.
Can Flash Loan be Attacked?
Yes. Let me give you a precedent, C.R.E.A.M. Finance has been under attack multiple times in 2021. One of the biggest heists involved $130 million. The culprits stole CREAM liquidity tokens, amounting to millions of dollars over an undisclosed amount of time. All the losses are visible on-chain, and the culprits have yet to be caught. Luckily, the loophole was only a part of Cream’s DeFi system, as the platform of their merging partner, Yearn Finance, remained safe. As with the majority of DeFi protocol hacks, the attackers used multiple flash loans and manipulated the pricing of the oracle. With the help of Yearn’s team, the platform quickly patched the vulnerability.
Does Flash Loan Attack Depends on Price Manipulation?
Most flash loan attacks depend on price manipulation, it’s necessary to counter this approach with decentralized pricing oracles. Good examples are Chainlink and Band Protocol. These platforms keep all protocols safe by presenting the accurate pricing of different cryptocurrencies. For example, DeFi attacks like the one that happened to dYdX won’t be possible because the protocols won’t get their price feed from a single DEX
Some Primitives in DeFi
How to prepare flash loan contract with Aave
How do you Identify flash loan transactions from Aave
How to prepare flash loan contract with dYdX.
How to Identify flash loan transactions from dYdX.
How to prepare flash loan contract with UniswapV2.
Identify flash loan transactions from UniswapV2. I
Current findings on flash loan services
Applications of Flash Loan
Flash Loan can be used for legitimate purposes such as;
Meaning of the above terms.
Arbitrage: Arbitrage in DeFi is a behavior to gain benefits by trading in between platforms supplying different price for an asset. Since the DeFi market reacts slower for events happening in the network than the real-world market, traders can take advantage of the market’s inefficiencies to buy and sell the cryptoassets at a different price to gain financial benefits.
Advantages of Arbitrage
Wash Trading
Advantage of Wash Trading
With Flash Loan, wash traders can manipulate the market without a large amount of capital as long as they can afford the potential loss and the gas fee.
Flash Liquidation
Advantage of Flash Liquidation
With Flash Loan, anyone can become a liquidator to make profits without much capital by buying the undercollateralized assets with a specific discount.
Recommendation/futuristic
Conclusion:
The paper takes the first step to study the working process of Flash Loan within three different platforms. In this work, we identified 76, 303 Flash Loan transactions and 1, 454 Flash Loan receivers. Furthermore, we evaluated the popularity of Flash Loan. When it comes to flash loans, the biggest risks that currently plague the DeFi ecosystem are data leaks, plus smart contract bugs that allow these attacks. I think the good news is that there are already specific platforms which tackle the current security challenges. OpenZeppelin is the perfect example. Its role in the whole ecosystem is to protect smart contracts and DeFi platforms as a whole. @Samuel94 do you think that OpenZepelin is the perfect tool that can protect smart contract and Defi platforms?
@Henry I don’t know much about the protocol, but you have already answered that it is a perfect solution for smart Contract protection
Is Flash Loan Worth the Stress?
You, probably, have come across one or two attack types in smart contracts, but if you haven’t, don’t worry. You can find various attacks on smart contracts here.You can also read my previous comment on Sandwich Attack— a kind of smart contract attack.
Like other smart contract attacks, Flash Loan Attacks result when some DeFi users take advantage of an innocuous feature.The bad actors take advantage of vulnerabilities to the detriment of users, the ecosystem, and the innocuous feature.
In a flash loan attack, a DeFi user borrows a large amount of funds without collateral. The fund is to be returned in a short time and with little interest paid to the borrowing liquidity pool. In this post, I will compare flash loans to traditional loans, highlighting some importance of flash loans. This way, we can understand if flash loans are actually worth the stress they put DeFi users through.
Why flash loan in the first place?
Most DeFi products are an improvement of Traditional Finance (TradFi). Flash loans are a part of these products.
Before now, in traditional finance, borrowing required a list of steps that must be checked before funds are released by financial institutions.
In TradFi, you have to qualify before you can even borrow. This is unlike flash loans where all you need is a computer, an Internet connection,and the necessary decentralized applications (DApps) on your computer.
TradFi encourages the use of collateral which limits the ease of securing loans and amount that can be obtained.
Comparison of Traditional loans and flash
This will be better understood if presented in a table format. Hence, I have attached a table to compare these two methods.
Image: A comparison between flash loans and traditional loans
Is the goal of flash loans as against Traditional loans achieved in the end?
Flash loans support the larger goal of DeFi which is to give users access to funds by cutting off third party services. DeFi also aims to secure users’ funds while doing this.
Although the security of DeFi is questionable, it has done a great job providing accessibility and decentralization. In essence, the goals of Flash Loans are partially achieved as flash loans have security issues.
Creation of a new challenge
The goal of a loan is to borrow funds, run some transactions/businesses, make some profits, pay back the capital, and pocket the profit. Traditional loans achieve this with little to no challenge, but the case of flash loans is different.
In making profits using flash loans, the opportunity can be limitless, hence users tend to exploit this weakness. In their research paper, @lnrdpss lists such weakness as:
These problems do not exist in TradFi. It is one challenge that flash loans bring which makes its goals partially achieved.
In conclusion, every new technology comes with its weaknesses. The goal of research and development is to help make the new technology better. This paper by @lnrdpss corroborates this statement by proffering solutions to tackling flash loan enabled attacks.In the end, flash loan is worth the stress for the many benefits that it embodies.
@Ulysses This is a well considered research and comparison. It’s knowledge enriching and thought provoking. I believe that the world will soon figure out how best to prevent DeFi attack.
INTRODUCTION
In the decentralized finance (DeFi) ecosystem, flash loans are common. They make it possible for borrowers to quickly profit on arbitrage possibilities.
Some people take advantage of this loan method. Learn more about flash loan assaults and how to avoid them by reading on.
Since the introduction of Decentralized Finance, a lot has changed in terms of how people perceive and use cryptocurrencies (DeFi). In particular, because it has a separate financial platform that offers a variety of cryptocurrencies, it provides more value to both lenders and borrowers.
The flash loan is one of the most well-liked loan kinds in the DeFi ecosystem because it provides borrowers with immediate access to arbitrage opportunities. borrow funds to purchase and sell digital assets, pay back the loan, and profit. The four main uses of a flashloan are collateral swap, wash trading, flash liquidation, and arbitrage.
Without access to significant sums of capital, flash loans create chances for financial operations that were previously unattainable. Their popularity is rising.
Unfortunately, although the concept is sound and effective, some individuals abuse this form of loan to cause harm to others (scam).
Background Lending Platform: An environment (usually a DeFi ecosystem) where depositors can secure funds (collateral) to lend assets
Reserve ratio: The lending platform sells the collateral and compels the loan to be liquidated when the minimal ratio between the value of the collateral and the value of the loan is reached (“amortized”).
Flash Loan: A recent innovation that enables customers to obtain unsecured loans as long as they repay the money in a single transaction.
A transaction is an activity carried out by an account that is controlled by a private key (an “Externally Held Account” or “EOA”) and that alters the state of the Ethereum blockchain, unless otherwise specified in the Official Gazette. EOAs are distinct from accounts kept by smart contracts since they are managed by user activities.
Arbitrage: Buying inexpensively in one market and selling expensively in another in order to take advantage of price disparities between markets.
Wash Trading: A trade that generates fake activity to give the impression that a platform or asset is more well-liked.
A quick loan is used to support a flash liquidation. A loan becomes available to anyone with secured capital known as the Liquidator.
Collateral swap: The borrower pays off the loan’s collateral and takes a new stake in another asset to avoid liquidation in the case of a significant price change.
Overview
Flash loans transform one type of borrowing by enclosing the complete lend-and-borrow process in a single transaction.
First, users receive the necessary assets from flash loan suppliers. They then execute the pre-planned procedures of the users. To carry out operations using borrowed assets, users communicate with other contracts. Users return the borrowed assets after execution is complete, with or without paying the additional fee that the flash loan providers impose. Finally, lenders of quick loans will look at their balance. They will promptly reverse the transaction if they find that users have returned no assets or assets insufficiently.
The figure below (Figure 1) shows the workflow of a Flash loan transaction.
The authors develop three models to identify flash loan transactions. Based on the identified patterns, 76,303 transactions were found on the Ethereum ledger. The numbers suggest that flash loan services are becoming more and more popular over time.
What Is a Flash Loan Attack?
A flash loan attack is an abuse of the smart contract security of a particular platform where an attacker usually borrows a lot of money that doesn’t require collateral. They then manipulate the price of a crypto asset on one exchange and quickly resell it on another.
There are some ways to avoid a flash loan attack, despite the fact that it can be devastating to a cryptocurrency. One method is to set a cap on how much can be borrowed in a single flash loan. The ability of hackers to borrow enough money to pay for the full attack would be made more challenging by this limit.
The process is quick and the attacker repeats the process several times before finishing and leaving without a trace.
With the way technology is advancing, DeFi instant loan attacks are becoming more and more common these days. Currently, more than 70 DeFi exploits have been used to steal a lot of money, totaling $1.5 billion. This trend will continue in the coming years as platform security is a difficult task.
The first difficulty relates to the fact that since blockchain technology is completely new, developers cannot cover all possible weaknesses. Another problem is that the system is developing very quickly and there is a lot of funding for each of these projects. The risk is high and many developers use different methods to find bugs in their systems. Some payday loan attackers use incorrect liquidity fund calculations. Others are miner attacks or coding errors. Unfortunately, weakness is also what makes it all possible.
The difficulty with smart contracts is that you have full control over the DeFi protocol. Once attackers understand the details of how it works, they can manipulate the flaws in the contract and use them to their advantage. This means that DeFi security is a delicate balance between the skills of protocol developers on the one hand and the skills of hackers on the other.
Another vulnerability has to do with the price data on the platform. With so many exchanges around the world, it is virtually impossible to find the true price of a cryptographic digital asset. This price difference makes arbitrage attractive. Due to the correct price movements, following the market is a great way to make money. However, flashloan attacks manipulate prices and take advantage of sudden fluctuations. When an attacker takes out a quick loan, it creates an artificial sell-off, which lowers the price of crypto assets.
Fortunately, there are already systems in place to prevent the abuse of unsecured loans. We would take a look at them after looking at some examples of flashloan attacks.
Example of flash loan attacks
There have been dozens of flash loan attacks so far. Here are just a few of the biggest.
Cream Finance Attack
C.R.E.A.M. Finance In 2021, was under attack several times. One of the biggest thefts involved $130 million. The culprits stole CREAM’s liquidity tokens and stole millions of dollars over an unknown period of time. The chain shows all the losses and the culprit has not been caught. Fortunately, the vulnerability is only part of Cream’s DeFi system, as their joint partner Yearn Finance’s platform remained secure. Like most DeFi protocol hacks, the attackers used multiple flash loans and manipulated oracle prices. With the help of the Yearn team, the platform quickly fixed the bug.
Alpha Homora Attack
In February 2021, the Alpha Homora protocol hack caused $37 million loss. The Flash loan attackers also used C.R.E.A.M. Finance’s Iron Bank which issued a series of quick loans. The Iron Bank is the lending arm of the Alpha Homora protocol.
The Hackers repeated the process several times until they accumulate CreamY USD (or cyUSD) and then use these tokens to borrow other cryptocurrencies.The Hack was very complex and involved many steps. Basically, the attackers heavily manipulated the HomoraBank v2 sUSD pool. They made a series of transactions and flash loans that allowed them to abuse the loan agreement between HomoraBank v2 and Iron Bank. You can take a closer look at the post-mortem analysis of the Alpha Homora attack to understand what the hackers did. Even in the case of just one borrower, they used rounding errors in loan calculations
Pancake BUNNY Attack
Hackers took about $3 million in May 2021 to test the PancakeBunny platform. The hacker first obtained sizable BNB loans through PancakeSwap, after which He played around with the trading pairs BUNNY/BNB and USDT/BNB.
After that, a massive flash loan provided the hacker with a large amount of BUNNY tokens, which they immediately dumped, returned the BNB, and disappeared with the prize money. With all these attempts, PancakeBunny’s price dropped from $146 to $6.17.
How to prevent loan flash attacks?
As attacks increase, security professionals are learning more about various flash loan exploits. All of the vulnerabilities in the example above have been patched and their emergence has led to two popular fixes.
Decentralized Pricing Oracles
This strategy needs to be matched with a decentralized price oracle because the majority of flash lending assaults depend on price manipulation. Band Protocol and Chainlink are two good examples. These platforms offer precise values for various cryptocurrencies while maintaining the security of all protocols. For instance, because the protocol does not get price feeds from the same DEX, DeFi attacks like dYdX are not feasible.
Alpha Homora now uses the Alpha Oracle Aggregator to prevent history from repeating itself. As the size of the DeFi market continues to grow, we will see more and more of these systems.
DeFi Security Platforms Implementation
The DeFi ecosystem uses advanced technologies that will change the future of the international financial system. This concern puts a lot of pressure on the whole system. The good news is that there are real platforms that solve today’s security challenges. OpenZeppelin is a good example. Its role in the entire ecosystem is to protect smart contracts and the DeFi platform as a whole.
In addition to smart contract management capabilities, solutions like Defender Sentinels provide continuous protection against credit crunch attacks. Developers can use this tool to automate defense strategies, quickly suspend entire systems, and deploy fixes.
This quick response is critical to limiting the potential damage of a Flash loan attack. Big companies like Yearn.finance, Foundation Labs, dYdX, Opyn, The Graph, PoolTogether and others use the platform to neutralize attacks on their systems.
TAKEAWAY
Flash loan attacks will inevitably occur and continue to occur. Despite all the suggested fixes, we must be aware that DeFi technology is still in its infancy and that we cannot afford to relax because every week hackers find new vulnerabilities that are not yet patched. Making the most of the current solutions is the only way for developers to survive, and even if they don’t work, they’ll always learn something new every time they’re assaulted.
Users must participate in DeFi efforts like stock trading, dividend farming, and liquidity mining because they also provide tremendous opportunities. Other DeFi lending protocols besides flashloan can be found here, along with the greatest cross-chain DeFi lending protocols.
Consider the risks carefully before investing, and never risk money you cannot afford to lose. Participation in DeFi is risk management, just like investing.
Citation: https://yajin.org/papers/flashloan.pdf
What Is a Flash Loan Attack — and How Do I Prevent It? | Bybit Learn
What Are Flash Loan Attacks? | Alexandria
It’s really amazing to see some nice comments and contributions here, especially from @Ulysses and @Freakytainment , they explained everything properly in a well strategized manner, and also they provided answers to some questions I had. But I also have a question.
In the mechanism of flashloan attacks, and after there’s been 5 attacks amd loss of millions of dollars, as a result of an exploit. Both art and magnificent attack were terms used to describe it. The assertions regarding the false token attack prevention, re-entrance attack prevention, and flash loan attack prevention were they unfounded? How is it possible for an audited protocol to be attacked like this?
Had read up on flash loans here, and then noticed this in todays news, flash lending exploit on Quickswap this afternoon:
