Flash Loans: How decentralized loans work without Collateral

Imagine being able to borrow millions for seconds – without having to deposit a single euro of your own capital, without having to prove creditworthiness, and without the lender even noticing. That sounds like pure science fiction, right? In the decentralized finance world (DeFi), however, this is reality. Welcome to Flash Loans – one of the most fascinating yet controversial innovations in the Blockchain ecosystem.

Understanding the Concept: Why Traditional Loans Do Not Work Here

To truly understand Flash Loans, we should first clarify how traditional lending works – and why these models are insufficient in the decentralized finance sector.

Two traditional ways to credit

The financial world knows two types of loans: unsecured and secured. An unsecured loan (, like a consumer loan ), is based on trust and creditworthiness. The bank checks your credit history and then decides whether you are trustworthy – similar to how Bob would lend money to his friend because he knows you. In institutions, interest rates replace this personal trust.

A secured loan works differently: You provide assets as collateral. If you do not repay the loan, you lose your car, your property, or your jewelry collection. The lender protects themselves against default risk.

In decentralized finance, these rules still theoretically apply – but the Blockchain enables something completely new.

Flash Loans: The Radical Difference

A Flash Loan is a loan where you absolutely do not need to provide any collateral. No assets, no credit checks, no weeks of processing. Instead, the entire transaction – from the loan issuance to usage to repayment – occurs within a single Blockchain transaction.

It works like this:

1. The loan is granted: Smart Contracts provide you with the requested amount – let's say 50,000 dollars in Ethereum (ETH).

2. You use the money: In the same transaction, you can deposit the money into other Smart Contracts, conduct trades, exploit price differences – practically anything you want.

3. The repayment is made immediately: At the end of the transaction, you will repay the money ( plus small fees ) in full.

If this does not happen, the entire transaction is reversed - as if it never took place. The lender keeps their money. This is not trust, this is Code Enforcement: The repayment is enforced in the program code.

Why does it work? Because [Ethereum]( and similar Blockchain platforms enable “programmable money”. You can chain multiple operations within a transaction and ensure that they all occur sequentially – or the entire chain will be discarded.

The practical sense behind it: Arbitrage and beyond

You are probably wondering: What do I need a loan for if I have to pay it back just seconds later? The answer lies in the possibilities between the loan and repayment.

The main use case is Arbitrage. Assume:

• Token A is traded on DEX platform 1 for $10
• The same token is traded on DEX platform 2 for $10.50

Normally, you would have to raise $10,000 yourself to buy 1,000 tokens. With a Flash Loan, you can borrow the money, buy on the cheap platform, sell on the expensive platform, and pay back the loan – all in one transaction:

1. Borrow $100,000 through a Flash Loan
2. Buy 10,000 tokens on DEX A for $100,000
3. Sell the same tokens on DEX B for $105,000
4. Repay the Flash Loan (, e.g. $100,500 including fees ).
5. Keep the profit of $4,500

That sounds like a guaranteed money printer – but it isn't. The reality looks bleaker: transaction fees, slippage ( price drops on large orders ), competing traders, and tight margins make profitable arbitrage a challenge. Thousands of bots try to take advantage of these opportunities daily, causing profit margins to shrink almost to zero.

Nevertheless, flash loans also offer other use cases: portfolio rebalancing, liquidations of underfunded positions, and testing trading strategies without risk.

The Dark Side: Flash Loan Attacks

In the experimental DeFi ecosystem, it was only a matter of time before someone discovered the dark sides of Flash Loans. The result: two spectacular attacks in 2020 that captured almost $1 Million – and that with minimal equity investment.

The first major attack: Market manipulation across multiple protocols

An attacker took out a flash loan from dYdX and strategically divided it among several DeFi protocols: Compound, Fulcrum, and Kyber. The plan was genius:

The attacker used part of the loan to short Fulcrum WBTC (Wrapped Bitcoin). This means: Fulcrum had to acquire WBTC. This information was forwarded to Kyber, which executed the order through Uniswap – a DEX with low liquidity. Due to this massive order, the price of WBTC rose significantly. Fulcrum paid way too much for the acquired WBTC.

At the same time, the attacker took out a Compound loan in WBTC at the manipulated high price (. With the borrowed WBTC, he exchanged it on Uniswap and made a decent profit. In the end, he repaid the dYdX loan and disappeared with the remaining ETH.

What was the problem? The bZx protocol ) running on Fulcrum ( used faulty price sources. It could not detect that the prices had been artificially manipulated.

) The Second Attack: Stablecoin Manipulation

Just days later – still targeting bZx – a similar attack occurred. The perpetrator took out a flash loan and exchanged a large portion into the stablecoin sUSD. Smart contracts are, despite their name, not really intelligent: They “know” that stablecoins are usually worth ###.

The attacker placed a huge order to buy sUSD $1 with borrowed ETH (. On Kyber, the price doubled – to ) per coin. The bZx oracle accepted this fake price information. The attacker was then able to take out a much larger ETH loan than would normally be allowed, as his $1 coins suddenly had the purchasing power of $2 coins. After repaying the flash loan, he absconded with the remaining funds.

$2 Are flash loans inherently evil?

Not necessarily. These attacks highlight a problem: Traditional financial institutions required massive capital reserves to manipulate markets. With Flash Loans, literally anyone can become a whale ###big investor( for a few seconds – without needing to invest large capital.

The good news: The security vulnerabilities were not in the Flash Loans themselves, but in the price oracles and the market design of the attacked protocols. Such attacks can be prevented with better oracles and more robust systems. Developers have learned since then.

The Future: Innovation or Risk?

Flash Loans represent both the strengths and weaknesses of the DeFi ecosystem. They enable true financial innovation – fast arbitrage, access to liquidity without collateral, new financial primitives.

At the same time, they demonstrate how quickly experimental technology can be exploited when the infrastructure is not mature. The key takeaway is not to condemn Flash Loans, but to make the entire DeFi ecosystem more robust.

With better oracles, smarter price feeds, and more intelligent protocol design, flash loans could become what they should be: a powerful tool for legitimate financial operations – without fraudsters being able to misuse them as a weapon.