Flash loans and how they work

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Well the term flash loans is commonly heard or associated with defi and it is something that one familiar with decentralized finance and it's workings must have heard about and am going to talk on it today as it's more like an innovation that makes it possible for one to borrow and they do that without placing any collateral whatsoever and the condition is that the said loan must be paid back in the same transaction block used for the borrowing.

These is just a fine innovation in the world of finance brought about by defi, and today I will talk about how this flash loan works, and their usecase and some key features we should know about.

How Flash Loans Work

Borrowing

Well the name or the idea of flash loan means someone has to take with the plan of paying back, which means borrowing is the first step in the flash loan but how is borrowing done in flash loan.

Well to do this you will need to make the request from a liquidity pool and you do it must be indicated that it's a flash loan you are requesting for specially and when such request is made them it's granted immediately because flash loans don't require collateral just as long as the precondition that it be repaid with the same transaction block will be met. That's just the idea.

Execution

After the borrowing then we have execution, in that the loan once borrowed is given almost immediately and there is no restriction as to what one uses the borrowed funds for.

That's to say you have every right to dictate how you use the money and for whatever purpose you can use it for and whatever financial services you wishes be it for asset swapping or even arbitrage trading, anything at all or any purpose you feel it's worth it and for any financial services appeals to you just like you would with your own funds.

Repayment

Then there comes the repayment part, this part must happen exactly when the transaction ends, it's expected that the person who borrowed this money should repay accordingly, the terms are that the principal amount borrowed ought to be repaid and ofcourse the borrower should add just a small accrued fee. Well what about in an event the borrower can't pay or don't want to pay back?

The transaction is made in the same transaction block both the borrowing and repayment so if the one that borrowed this money don't want to repay again according to this terms the system is such that the transaction is immediately reversed in an instant of time and the borrowers intent to put the lender to great risk is nullified, such is how it's done here as it comes flash loans on defi. The repayment must happen in same transaction block.

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Use Cases

• Arbitrage

we have arbitrage as one of the great usecase, that is some of the things you can possibly do with your flash loan on defi by doing arbitrage trading.

This merely involves being smart enough to capitalize on price differences of a given asset across many platforms and you can do it for many asset class as possible, that's the idea of arbitrage and many make a living with this.

• Collateral Swapping

This is another wonderful usecase and it literally is what the name says, you can literally swap collateral. Let's say you took a loan from a platform and use a particular asset as collateral you can literally switch the collateral by using another asset from a different platform all together if that suits your need at the time.

• Self-Liquidation

This is another thing that flash loans could be used for and that's to avoid liquidation, when loans is much is could lead to liquidation but with flash loans one could choose to use them to settle previous loans they were owing before, with what goal?

This would help ensure they don't face the liquidation penalty of having this excess loans.

Key Features

• No Collateral Needed: Well to acquire a flash loan from defi liquidity pool you don't need any collateral at all but borrowers are made to repay within the same transaction block ensuring the one lending is protected.

• Instant Execution: Also the whole transaction is excuted once requested in matter of seconds even, very swift and reliable.

• Smart Contract Driven: Well we know the terms here on flash loans so far, which is flash loans are given immediately they are requested, no collateral is needed for flash loan because the borrower would pay back within the same transaction and if the borrower does not everything reverses now it's smart contract that ensures that this is done so, automatically enforcing rules.

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Conclusion

Well not everyone really understand how this works as only pro traders or developers do use them even though we might have heard of it, well in as much as we want to participate in it watch for for dangers too as all too well some nefarious individuals could choose to take advantage of things here for their own ill intent.