Imagine you could borrow a million dollars instantly and with no collateral. The whole thing would happen anonymously, and you wouldn't need to assume liability for the loan.
Sounds crazy? That, in a nutshell, is how flash loans work. In the financial demimonde of DeFi they’re perfectly normal and growing in popularity – not least for their facility in making profitable arbitrage trades.
You'll need a big enough position to make it worthwhile but the barriers to entry are low. No need for institutional backing or SEC registration. With a bit of effort and the right tools, anyone can take part.
At a glance
- Flash loans are trustless DeFi transactions that allow users to borrow funds without collateral.
- Traders can use them to identify arbitrage opportunities across decentralized exchanges (DEXs).
- To access a flash loan provider liquidity pool provider like Aave (AAVE), you'll need to set up a smart contract compatible its protocol.
- There are some barriers. Technical complexity can be off-putting, and opportunities arise from tiny price differentials. You'll need knowledge, tools, and the capability to act fast.
What are flash loans?
Flash loans enable DeFi users to borrow cryptocurrencies from an on-chain liquidity pool. There’s no application to complete and no need to provide a security. The principal just needs to be returned to the pool within the same blockchain transaction (plus a fee).
If the borrower fails to do that, the transaction is completely reverted. Risk of default is zero. Users gain greater access to assets without undermining the solvency of the on-chain liquidity pool.
Practices unthinkable in traditional finance are a daily reality in DeFi, and for retail traders, that creates opportunities. First launched on the Aave DeFi protocol in 2020, platforms including dYdX, Equalizer Finance, Uniswap, SushiSwap, and DeFiSaver have all moved to offer flash loan capability.
How does flash loan arbitrage work?
Blockchain transactions typically resolve in a few seconds, so the use cases for flash loans must be equally quick. Arbitrage trades are one of the most popular.
Flash loan arbitrage leverages price discrepancies for the same crypto asset across different decentralized exchanges.
For example: say the price of ETH on Uniswap is $3,000 – but on SushiSwap its trading for $3,001. That creates an opportunity to buy ETH at a lower price and sell it at a higher price.
But you'll have to act fast. Arbitrage depends on micro price differentials and opportunities in the crypto market typically last only a few seconds – traders require significant capital and fast execution to achieve a successful outcome.
Source: SoluLab
Flash loans can provide the capital, and they come with built-in risk mitigation. If you can't repay in full (plus fee) by the end of the blockchain transaction, everything reverts instantly.
Think of them like Schrödinger's loan. If they generate a profit, they’re real. If they don't, they never happened.
How to use flash loans for arbitrage
To use flash loans for arbitrage you'll need a solid understanding of DeFi fundamentals like smart contracts, some basic familiarity with coding, and comfort with the mechanics of on-chain transactions.
Then you’ll need to access a liquidity pool of flash loan providers and a smart contract that interacts with their flash loan protocol.
If you opted to create a smart contract on Aave v3, for example, you would have two configuration options:
- flashLoan (): This function allows users to access liquidity across multiple reserves on Aave in a single transaction.
- flashLoanSimple (): This function allows users to access the liquidity of a single reserve pool.
Here is a simplified example based on Aave's flash loan documentation:
- It's then configured to use the flashLoan () or flashLoanSimple () command to request a flash loan for a specified amount.
- After verification, the Aave pool transfers the requested amount to the smart contract.
- The executeOperation () function then runs your pre-set custom logic for the arbitrage operation (Eg. buy 10,000 ETH on Uniswap and sell it on SushiSwap).
- Next, you approve the repayment of the flash loan plus fee.
The multi-step process happens in one fell swoop. If any part of the transaction is unsuccessful, the entire operation is reverted.
How to profit from flash loan arbitrage
Start by identifying a price discrepancy with specialized monitoring software that continually checks prices on various DEXs to detect arbitrage opportunities.
Let's say you find DOGE trading at $0.5 on Uniswap and at $0.6 on SushiSwap. These are the steps to follow:
Flash Loan Initiation
Your smart contract initiates a flash loan where you borrow $500K in USDC stablecoins.
Buying Low
The flash loan smart contract will buy $500K worth of DOGE as configured at $0.5 from Uniswap, for a total of 1 million DOGE tokens.
Selling High
Your flash loan smart contract then immediately sells the 1 million DOGE tokens at $0.6 per token on SushiSwap, for a net profit (before fee) of $100K.
Repayment
You approve the repayment of the flash loan and fee. Aave v3 charges a fee of 0.05% on the loan amount, which equals $25,000 in this case. You repay $525K and pocket the remaining $75K as your net profit.
Loan liquidation
Decentralized crypto lending protocols incentivize third-party market participants to liquidate unhealthy loans by paying off the loan on behalf of the borrower.
When the market value of a loan collateral drops below a certain threshold, the lending protocol allows third-parties to purchase the collateral and liquidate the loan.
As a liquidator you're incentivized to buy the collateral at a discounted price. You may also receive a fee called a liquidation bonus.
Flash loans and cybersecurity
Flash loans have been used by hackers to attack DeFi protocols. Once a vulnerability in a protocol is uncovered, attackers can sometimes use flash loans to undermine specific protocol functions.
In one high profile example, DeFi yield farming platform Alpha Homora lost approximately $37 million when hackers used flash loans to borrow cryptocurrencies and then manipulate their prices on the platform. They quickly opened and liquidated positions, then instantly executed trades that leveraged the resulting price changes.
The take away
Things don't always go to plan. In 2023 a blockchain arbitrage bot ran a series of sophisticated Ethereum transactions using a $200 million flash loan – all for a net profit of just $3.24. Analysts at Arkham Intelligence said the bot was configured to green light any transaction that resulted in a profit, even if the net gain was miniscule.
It underlines the fact that any budding DeFi arbitrageur should expect to get comfortable with smart contract programming commands or consider using no-code platforms like Defi Saver. Granular control over the contract's pre-set parameters could determine the difference between profit …. or less profit.
There are other risks. Technical risks include vulnerabilities in smart contracts, and uncertainty around timely block inclusion. There are also economic risks due to volatility in gas fees and the changing maximum extractable value (MEV) practices employed by block validators.
As new off-chain and on-chain execution models emerge, look for flash loan arbitrage to become more secure, efficient, and accessible to newcomers.
© 2025 Benzinga.com. Benzinga does not provide investment advice. All rights reserved.
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