What Is Flash Loan?

What makes flash loans possible is that blockchain transactions are indivisible (atomic). Within a single transaction, the user takes the loan, uses the funds in whatever smart contract steps they like, and returns the loan with the protocol fee before the transaction ends. If repayment does not happen, the transaction is cancelled entirely; this way there is no default risk for the lending pool. Aave is one of the protocols that popularized this model.

Legitimate uses include arbitrage between exchanges, swapping the collateral of a debt position in a single transaction, moving debt to another protocol, and performing liquidations without one's own capital. For example, a user who notices a price difference between two decentralized exchanges can borrow a large amount, buy on the cheaper one and sell on the more expensive one; if the profit is sufficient, they keep the difference after repaying the loan.

The same feature also magnifies the risks, because it gives attackers temporarily very large capital. Flash loans have often been used in price manipulation and governance attacks, especially against protocols that use a weak price oracle. The problem is usually not the flash loan itself but a design flaw in the target protocol.