How can a flashloan even be possible?

A flashloan is a loan that doesn’t need any collateral from the user, it can be a very big amount e.g. $1’000’000 and has minimal risk for both the borrower and the lender, namely the gas fee for the borrower and the opportunity cost to earn a percentage of the loan amount for the lender, in case the loan fails.

But how is that possible?

First of all, it is only possible on blockchain networks where transactions are atomic. This means that a transaction is either fully executed or not executed at all (i.e. the state is reverted to the initial state before the transaction started).

Additionally, the borrower has to borrow and return the funds within the same transaction block, otherwise the entire transaction fails and the blockchain state is rolled back.

The steps involved are usually:

• Request a Loan: The borrower makes the request
• Loan approval: the lender approves the loan and notifies the borrower
• Use the funds: the borrower uses the funds, e.g. for arbitrage
• Repay the Loan: the lender repays the loan or grants access to the lender to corresponding amount from his own account
• Transaction validatioon: The lender’s smart contract checks whether the loan + fees has been repaid. If not, it reverts the entire transaction, preventing the lender from losing money.

To see more about the implementation, see intuition of how to implement a flashloan.

No collateral needed

Normally, loans require collateral to secure them. However, as we saw, using flashloans:

• if the borrower doesn’t repay the loan in one transaction, everything is reverted. Therefore:
• the lender’s money are never at risk. Either the lender gets repaid, or the transaction never happens.

Risks

As everything is controlled by smart contracts, flashloans’ primary risk is smart contract risk.

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