Flash loans are a groundbreaking innovation within the decentralized finance (DeFi) ecosystem. Unlike traditional loans, flash loans are uncollateralized and must be repaid within the same transaction block. This unique characteristic allows for a variety of advanced financial strategies that were previously impossible. Here, we explore the primary use cases of flash loans, shedding light on their transformative potential in DeFi.
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Arbitrage is the most prevalent use case for flash loans. It involves exploiting price discrepancies of an asset across different markets or exchanges. For instance, if a token is priced at $1 on Exchange A and $1.10 on Exchange B, a trader can borrow a large sum via a flash loan, purchase the token on Exchange A, sell it on Exchange B, repay the loan, and pocket the difference—all within one transaction. This rapid execution maximizes profit opportunities and minimizes risk associated with price fluctuations.
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Flash loans are essential in the liquidation process on DeFi lending platforms. When a borrower's collateral falls below the required threshold, liquidators can use flash loans to quickly repay the debt, liquidate the collateral, and claim a liquidation bonus. This method ensures that liquidators do not need to hold large amounts of volatile assets, reducing their risk exposure while maintaining the stability of the lending platform​.
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Collateral swapping allows borrowers to replace their collateral without repaying their loan. For example, if a borrower fears that their current collateral might lose value, they can use a flash loan to temporarily repay the loan, swap the collateral for a more stable asset, and then re-borrow against the new collateral. This process helps in managing risk and maintaining the borrowing capacity without needing additional upfront capital​.
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Borrowers can leverage flash loans to refinance their existing loans to benefit from better interest rates on different platforms. Suppose a user has a loan with a high-interest rate on Platform A but finds a better rate on Platform B. They can use a flash loan to repay the original loan, transfer their collateral to Platform B, and secure the new loan at a lower rate. This strategy enables efficient management of debt without needing significant liquidity upfront​.
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Flash minting is an innovative but less common use case where new tokens are temporarily created for a single transaction and then destroyed. This mechanism can be used for various complex financial operations, although its full potential and applications are still being explored. It highlights the flexibility and programmability of flash loans within the DeFi landscape​.
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Flash loans are revolutionizing DeFi by enabling complex financial strategies that enhance liquidity, reduce risk, and optimize returns. Platforms like Equalizer Finance are at the forefront of this innovation, providing robust and secure environments for executing flash loans with low fees and high efficiency​​. As the DeFi space continues to evolve, the utility and applications of flash loans are expected to expand, further solidifying their role in the future of decentralized finance.
