The idea of flash loans was introduced in 2020 by an Ethereum lending platform, Aave. Even though the concept is relatively new, several crypto enthusiasts are interested in it. Flash loans are undoubtedly highly innovative in cryptocurrency, and several individuals even argue that they are incredibly useful.

With all this in context, let’s take a closer look at them.

Flash Loans Definition 

A flash loan is a relatively new kind of uncollateralised lending that has gained popularity across several DeFi protocols based on the Ethereum network. This kind of loan can be useful in some instances for traders who want to quickly profit from arbitrage opportunities when crypto is priced differently by two markets.

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Factors That Make Flash Loans Unique

Flash loans operate just like traditional loans but come with certain unique premises and terms:

• Unsecured loan

A flash loan is an unsecured loan, implying that there is no requirement for collateral. 

But, this does not mean that the lender of a flash loan does not receive the money back in the event of a non-payment. Collateral is typically present in a traditional loan to ensure that the lender receives the money back in case of a non-payment.

However, it's worth noting that flash loans happen within a short timeframe (usually a few minutes or seconds). This implies that even though no collateral is necessary, the borrower should return the entire borrowed amount right away.

• Usage of smart contracts

Regarding flash loans, the borrower must repay the entire loan amount before the completion of a transaction. The smart contract reverses the transaction if this rule is not followed. Also, in such a case, the loan is nullified as if it never occurred.

• Instantaneous transactions

Obtaining approval for a traditional loan is usually a long procedure. But, a flash loan is expedited instantly, implying that the smart contract of the loan should be fulfilled during the transaction for which it is lent out. Thus, the borrower must call on other smart contracts using the loaned capital to carry out instant trades.

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Uses Of Flash Loans

Flash loans can be used for:

• Collateral swaps
• Debt refinancing
• Flash loan arbitrage

Bottom Line

It seems flash loans will significantly impact the future of DeFi. Even though the use cases for flash loan transactions are presently restricted, they can open up an array of new DeFi operations. They demonstrate an array of options for developing a new financial system.