Thanks a lot @abcoathup for putting this post together from the original Twitter thread, and shout-out to @albert and @fiiiu, as many of the thoughts in this thread come from a recent discussion with them!

To everyone not following the crypto scene, a new use case that is an actual game changer has come up recently. I’m talking about flash loans.

Photo by Florian Rieder from FreeImages

DeFi

Decentralized Finance (DeFi, for short) has become one of the most popular use cases.

Financial instruments from the traditional world, such as loans and derivatives, have been encoded as smart contracts and run on the Ethereum decentralized network.

It’s easy to see why DeFi took off. The first and most widespread blockchain (Bitcoin) was used for monetary transactions.

It makes sense that the next big step would be instruments operating on that value, which took so much effort to move on chain.

Now, the major value of DeFi relied on lack of intermediaries, free access, and borderless transactions, but not on inherently new financial instruments.

Most of what we had seen had a clear parallel from the traditional financial world.

That is, until flash loans.

What is a flash loan?

These are loans that you can take, without any collateral, for ridiculously large amounts – as long as you return the loaned assets immediately right after you borrowed them.

In blockchain terms, as long as you return them in the same transaction

While this does not sound very interesting, there is now a huge amount of opportunities that were previously reserved for large holders.

Anyone, without any upfront capital, can now participate in (let’s say) arbitrage operations in the DeFi scene.

This means that, for the first time ever, you don’t need money to make more money.

Not only this has no parallel with the real financial world, but it’s also disrupting the DeFi scene itself.

Governance and tokenomics

When anyone can become a whale for an instant, there are basic assumptions that break. Governance is one of them.

Many token-based networks fall as well. A common mechanic was presuming that large holders would not act maliciously, since doing so would depreciate the token and thus their assets.

Now anyone can become a whale, break the network, and cash out – in a single transaction.

And the best thing is that we are just scratching the surface of this. It’s difficult to understand what may come up next.

@Austin-Williams suggested flash-mints, where instead of borrowing, you just print a lot of money as long as you burn it right away.

There are many resources to learn more about flash loans. This analysis from Aave, one of the protocols that implement them, is a good read:

And it’s very likely that, if you’re outside crypto and you have heard about this, was because of a recent hack to bzx.

Yet the beauty of it is that it’s not even clear if it was an actual hack, or just someone cleverly composing protocols in unexpected ways.

Close

To close, I’m super excited about this and what may come up. We now have a true finance democratizing tool in our hands.

And also, we have something entirely new to look into from a security perspective.

It’s going to be challenging, and it’s going to be awesome!!




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