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In the world of DeFi, there is a special kind of loan called a flash loan. Unlike traditional loans, flash loans don’t require you to provide any guarantee upfront. Instead, you can borrow money instantly and pay it back within the same transaction.
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Unlike loans from banks, flash loans are completely decentralized and operate within the DeFi ecosystem. This means there is no need for a bank to be involved in the process.
What’s interesting about flash loans is how fast they are. While traditional loans can last for many years, a flash loan needs to be repaid in just minutes. The loan is executed through a smart contract, which automatically borrows the money and repays it with interest, all in one go.
Before a flash loan can be confirmed and added to the blockchain, it goes through a validation process that typically takes a few seconds to a few minutes. During this time, the network needs to agree that the transaction is valid. If it’s not approved, the transaction becomes void and doesn’t get recorded on the blockchain.
If a borrower fails to repay the loan before the validation process is complete, the network cancels the transaction. In this case, the lender receives their assets back, as if the loan never took place. This is possible because the tokens weren’t transferred to the borrower in the first place.
How Do Flash Loans Differ From Traditional Loans?
Firstly, they don’t require any guarantee, making them unsecured loans.
Instead of relying on physical assets, flash loans rely on smart contracts to ensure repayment.
Smart contracts are special lines of code that run on a blockchain. They are automatically executed when certain conditions are met. In the case of flash loans, smart contracts make sure that the borrower can immediately repay the loan with interest before the loan is approved and executed.
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