Flash Loans: What Are They & How Do They Work?

Flash loans have helped DeFi users earn millions of dollars — legally and illegally. In this guide, we’ll cover the fundamentals of flash loans including how you can get started, the most common ways of marking money, and how flash loans work. 

What is a flash loan? 

With a flash loan, investors borrow funds, execute a specific transaction, and repay the loan within a single transaction block. 

Flash loans are often used by experienced traders and developers for arbitrage opportunities. However, flash loans come with substantial risks and require a deep understanding of the technology involved.

How do flash loans work? 

Here’s a simplified version of how flash loans work. 

1. You apply for a flash loan on a relevant platform (ex. Aave, Uniswap). 
2. You create a logic for the loan through coding. This logic shows a series of sub-transactions — such as sales, trades — that will be used to generate a profit. The final transaction should result in you paying off the loan. 
3. If your loan is approved, the sub-transactions outlined in the step above will be completed in a single blockchain transaction. 

While this sounds fairly simple, applying for a flash loan requires knowledge of coding and blockchain smart contracts. If any one part of the transaction logic lined out through code fails, the flash loan won’t be approved. 

Best flash loan platforms 

Here are some popular platforms that can be used to take out a flash loan. 

• Aave: Aave is one of the most popular lending protocols built on Ethereum!  
• Equalizer Finance: Equalizer Finance enables flash loans on multiple chains like Ethereum, Binance Smart Chain, Optimism, and Polygon.  
• Uniswap: The world’s biggest decentralized exchange also supports flash loans! 
• DeFiSaver: Take out flash loans with logic created through templates — no coding required! 

What are the benefits of flash loans? 

Flash loans offer multiple advantages over traditional loans! 

No collateral required: With flash loans, there is no need to post any collateral for your transaction! 

Low cost: Because flash loans are typically less expensive than traditional loans because they don’t require middlemen like underwriters and loan agents! Platforms like Aave offer flash loans for as low as 0.09%. 

No credit score required: Unlike traditional loans, flash loans do not require any kind of credit check. In fact, DeFi platforms don’t ask for your identity before giving out a flash loan! 

What happens if I can’t pay back a flash loan? 

If you can’t pay back a flash loan, you won’t receive the loan in the first place. 

Remember, flash loans only execute if the loan can be paid off after you make your transactions. If you can’t generate a profit, the loan will not execute. 

How to make money with flash loans

Traders often make money on flash loans through arbitrage — or taking advantage of different prices on different exchanges. To better understand how this works, let’s take a look at a simplified example of an arbitrage opportunity. 

Cryptocurrency ABC is trading for $20 on Exchange A. 

Cryptocurrency ABC is trading for $20.75 on Exchange B. 

By buying ABC on Exchange A and selling it on Exchange B, you have the opportunity to make $.75 on a transaction. You can use a flash loan to execute this trade multiple times and maximize your potential profits! 

However, it’s important to note that the example above does not take into account fees  and other expenses. Because of associated costs, the margin for flash loan arbitrage is often very low. 

In most cases, you’ll need a deep understanding of arbitrage and smart contracts to make a profit with flash loans. 

Are flash loans illegal? 

Flash loans are completely legal. However, flash loans are often used as a means to exploit vulnerabilities in DeFi contracts and steal cryptocurrency. In the past, the FBI even issued a warning about cyber criminals using flash loans. 

It’s important to note that flash loans themselves are not the problem — rather, criminals are using flash loans as a source of capital to take advantage of smart contract vulnerabilities. 

Can flash loans be used for hacks? 

As noted above, flash loans have been used to take advantage of smart contract vulnerabilities and manipulate the market. In one case, flash loans were used to steal more than $320 million from a DeFi platform. 

Remember, it’s not a good idea to use flash loans for hacks. Using flash loans for illegal activities can lead to jail time. 

Can I do a flash loan without coding? 

In recent years, platforms like DeFi Saver have popped to allow users to take out flash loans without coding knowledge. 

Alternatively, you can take a look at documentation from flash loan providers like Aave to learn how to get started with coding flash loans. 

Are crypto loans taxable? 

While crypto loans are by themselves not taxable through crypto taxes, any profits you make on cryptocurrency trades from loans are subject to capital gains tax. The same concept applies to flash loans. 

For more information, check out our guide to cryptocurrency loans tax.