It is human nature to explore and become familiar with the world around us. As we seek out new opportunities in uncharted terrain, unknown dangers are often looming around every corner to challenge those who bravely venture into these new frontiers. This was the case for the first European explorers who challenged the flat Earth narrative and sailed westward, and later for the American pioneers Lewis and Clark making the difficult journey to the Pacific coast of California. Today, as much of the physical world has since been plotted, the digital terrain has become the new frontier for human exploration. Within it, blockchain and cryptocurrency is one very new space with some of the wildest areas to chart; attracting pioneers in search of new financial opportunities, and creating new and previously unforeseen financial dangers.
Within the cryptocurrency space, Decentralized Finance (DeFi) has become one of the most popular areas in 2020. It provides high-yield returns for crypto investors by staking (holding) crypto with an exchange for a specific period of time. It also has no fees, like the ones associated with traditional interest-bearing financial instruments like fiat currencies. Within the wildly popular and rapidly growing subspace within crypto, new opportunities have also opened the doors to a new danger which has recently come to light, and threatens to put the entire DeFi economy at risk.
What Are Flash Loans?
Flash loans are zero-collateral crypto loans made possible by a borrowing and lending application built on Ethereum called the Aave protocol. These loans are borrowed and rapidly repaid with a nominal fee, all within a single Ethereum transaction. They enable experienced crypto investors to accumulate leverage on a given crypto’s position. With flash lending, a trader can borrow from a lender, buy a token on one decentralized exchange (DEX), sell the token on another DEX for a higher price, repay the lender, and then retain any profit; all in a single transaction. Users can lend and borrow Ethereum and countless other tokens using Aave. The protocol gets its liquidity when users stake their tokens to earn interest based on the current interest rate over a defined period of time.
What Are The Intended Uses Of Flash Loans?
Flash loans are a unique and novel feature of the DeFi ecosystem. They are designed to help people gain access to a substantial amount of liquidity in the form of cryptocurrency without providing any actual collateral. Anyone can now borrow this crypto-backed liquidity, use it for arbitrage, debt refinance, swap, trade, borrow or lend, then repay it in a single transaction. The key is that the borrower must return the original amount with a nominal fee; otherwise, the entire transaction will be voided.
Why Are Flash Loan Attacks So Dangerous?
2020 has reminded us that flash loan attacks are a major liability for DeFi and crypto adoption overall. There is something innately dangerous in providing anonymous individuals with quick access to large sums of capital. The first successful flash loan attack was on DeFi project, bZa, which lost $350K back in February when hackers successfully leveraged the company’s pricing algorithm to force the protocol to release funds. Value DeFi was one company in which attackers took advantage of their uncollateralized loans, then purchased and sold the funds between stablecoins DAI and USDC after depositing funds into Value DeFi's MultiStables vault. Origin Protocol became the most recent victim of a flash loan attack, losing roughly $7M when an attacker successfully created a rebase event inside the second mint after funds moved to OUSD (Origin Dollar) from the first large mint, but before the supply of OUSD increased. The result was massive rebase for the attacker, and all parties of the contract. The attacker, having received their first large OUSD mint, received more OUSD than the contract had assets for.
Understanding The Negative Effects of Flash Loan Attacks on DeFi
It is no secret that DeFi is innately a place that promotes high-risk investing. Nevertheless, flash loan attacks have made this landscape an even riskier one to navigate. While some would argue that flash loans are an essential part of DeFi and increase the usability of the overall ecosystem, the viral spread of bad press this year surrounding these high-profile attacks leave crypto newcomers and potential institutional investors with an image of unregulated gangsters and schemers, which is ultimately not a good thing for crypto adoption. DeFi is certainly showing the public what an efficient financial ecosystem looks like when you remove intermediaries and have programmable money, but it must not be at the expense of investors, companies, and the crypto industry as a whole.
YouHodler as an Alternative to Flash Loans
YouHodler is a crypto-backed loan platform that is, unlike DeFi, a safe and centralized solution. Their mission is to help people to start using their crypto assets sitting in storage. They are a member of the Blockchain Association for dispute resolution, and an active member of the Crypto Valley Association’s Western Chapter. YouHodler uses Ledger Vault for its massive $150 million crime pooled insurance and uses industry best practices for their crypto storage.
DeFi is decentralized. By design, this means DeFi software cannot be updated. Any programmer will tell you, creating software without vulnerabilities is nearly impossible. An inability to update software has huge implications for DeFi on the road ahead. This is why YouHodler’s centralized platform makes it much more secure when working with crypto-backed loans and crypto savings accounts when compared to other DeFi platforms, as software can be patched and customers protected.
Can We Stop Flash Loan Attacks?
Flash loan attacks are still a developing story in the world of DeFi. It is still undetermined as to how to appropriately stop or prevent flash loan attacks. A few potential solutions to consider are to disable deposits and withdrawals in the same transaction, increase gas fees, implement a block delay, convince lending protocols to stop offering this service, or require proof to validate if your balance hasn’t changed after the flash loan. Investors looking for solutions to immediate concerns around DeFi can look to YouHodler for a sense of reassurance in a world of unknowns.