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What Is Flash Loan Attack and How to Prevent It?

UTC by Beatrice Mastropietro · 8 min read
What Is Flash Loan Attack and How to Prevent It?
Photo: Shutterstock

A flash loan attack is a type of attack where a cyber thief takes out a flash loan from a lending protocol and uses it in conjunction with various types of gimmickry to manipulate the market. In this guide, we will look at some examples of past attacks as well as discuss how to prevent them.

As the DeFi industry continues to grow, so do the number of attacks on these protocols. One example of them is the flash loan attack.

In a flash loan attack, a hacker borrows a large amount of money from a protocol and then uses that money to destabilize the protocol. This can be done by buying up many of the protocol’s tokens and then selling them all at once, causing the price to plummet.

Flash Loan Definition

A flash loan is a type of cryptocurrency loan that allows users to borrow funds without putting up any collateral. Flash loans are typically used for short-term trading strategies and are often repaid within the same day.  Flash loans have become increasingly popular in recent years as they offer a way to gain access to liquidity quickly without going through a traditional lending process. They are possible due to decentralized lending protocols that use smart contracts to facilitate loan transactions. These protocols act as an intermediary between the borrower and the lender, and they use collateralized tokens to secure the loan.

When a borrower wants to take out a flash loan, they first need to have collateralized tokens in their wallet. These tokens are used as collateral for the loan and are held by the lending protocol until the loan is repaid.

The borrower then sends a request to the lending protocol for the desired amount of funds. If the request is approved, the funds are instantly transferred to the borrower’s wallet.

Once the borrower has the funds, they can use them for whatever purpose they desire. The loan must be repaid within a certain time frame, typically within 24 hours. The collateralized tokens are forfeited to the lending protocol if the loan is not repaid.

Flash loans are a new and innovative way to gain access to liquidity, but they come with some risks. First, because any collateral does not back flash loans, they are much riskier than traditional loans.

Second, flash loans are often used for margin trading and other speculative activities. This means that borrowers could end up losing more money than they borrowed if the market moves against them.

Further, flash loans are subject to volatility risks. The price of the collateralized tokens could drop sharply before the loan is repaid, putting the borrower at risk of losing their collateral.

Flash Loan Attack Definition

A flash loan attack is a type of cryptocurrency theft that occurs when a hacker borrows a large amount of digital currency using a flash loan and then sends the currency to an exchange where they can sell it for a profit. This type of attack is possible because flash loans allow users to borrow money without putting up any collateral, making them very attractive to hackers.

Flash loan attacks have become more common in recent years as the value of cryptocurrencies has risen, and they are one of the major security concerns for digital currency exchanges.

Flash loan attacks can be difficult to detect and prevent because they often involve complex financial transactions. For this reason, it is important for organizations to carefully monitor their smart contracts and decentralized apps for vulnerabilities that flash loan attacks could exploit.

Why Flash Loan Attacks Happen

As we all know, the DeFi lending protocol Aave (AAVE) was attacked on Christmas day 2020. This is not the first time that a flash loan attack has occurred in the cryptocurrency space. In fact, there have been several such attacks in the past few years. So, why do these attacks keep happening?

There are a few reasons for this. First of all, flash loan attacks are relatively easy to execute. All you need is a large amount of collateral and access to a liquidity pool. Once you have these things, you can easily borrow a large amount of money and use it to buy up a bunch of assets. This allows you to quickly profit off of the price difference between the two assets.

Another reason why flash loan attacks keep happening is that they are often profitable. For example, in the Aave attack, the attacker was able to make a profit of over $7 million. This is a huge sum of money, and it’s likely that other attackers have made similar amounts of money from other flash loan attacks.

Finally, it’s worth noting that these attacks often have a negative impact on the cryptocurrency space as a whole. They cause people to lose faith in decentralized exchanges and protocols, and they can also lead to losses for innocent users who are caught up in the attack. For all these reasons, it’s important that we find ways to prevent flash loan attacks from happening in the future.

Consequences of Flash Loan Attacks

A flash loan attack can have serious consequences for both the victim and the attacker. A flash loan attack can result in loss of funds, loss of reputation, and even legal action for the victim. A flash loan attack can lead to financial losses, legal penalties, and reputational damage for the attacker.

Flash loan attacks have been around for years. However, with the rise of decentralized finance (DeFi), flash loan attacks have become more prevalent. This is because DeFi protocols often use smart contracts to automate transactions. Smart contracts are vulnerable to attack if they are not properly designed or implemented.

Flash loan attacks are a serious threat to the DeFi space. They highlight the need for rigorous security testing of smart contracts before they are deployed on mainnet. They also underscore the importance of proper risk management when using DeFi protocols.

The Biggest Flash Loan Attacks Examples

Flash loan attacks have become more and more common in the cryptocurrency world. Let’s take a look at some of the biggest flash loan attacks that have occurred to date.

  1. The DAO Attack

The DAO was a decentralized autonomous organization built on the Ethereum (ETH) blockchain. It was intended to be a completely decentralized way of funding projects on the Ethereum network. However, in June 2016, an attacker exploited a flaw in the DAO’s code and managed to siphon off approximately $50 million worth of ether from the organization.

  1. The bZx Protocol Attack

The bZx protocol is a decentralized lending platform built on the Ethereum blockchain. In February 2019, an attacker took out a flash loan of 50,000 ETH and used it to manipulate the price of an Ethereum-based token called WETH. The attacker then sold their WETH for a profit of over $800,000.

  1. The dForce Attack

dForce is a decentralized lending platform built on the Ethereum blockchain. In April 2020, an attacker took out a flash loan of 10,000 ETH and used it to manipulate the price of the USDC stablecoin. The attacker then sold their USDC for a profit of over $6 million.

  1. The MakerDAO Attack

MakerDAO is a decentralized lending platform built on the Ethereum blockchain. In November 2019, an attacker took out a flash loan of 500 ETH and used it to manipulate the price of the DAI stablecoin. The attacker then sold their DAI for a profit of over $4 million.

These are just a few examples of flash loan attacks that have taken place in the cryptocurrency world. As you can see, these attacks can be quite lucrative for attackers. And unfortunately, they are becoming more and more common.

Prevention of Flash Loan Attacks

As the DeFi ecosystem grows, so does the risk of flash loan attacks. Here are some ways to prevent them:

  • Use a decentralized exchange. A DEX doesn’t have to hold your assets, so there’s no single point of attack.
  • Use a non-custodial wallet. This keeps your keys safe and gives you full control over your funds.
  • Use a decentralized lending platform: These platforms are less likely to be attacked as they don’t hold user assets.
  • Be aware of the risks. Keep up with the latest news and developments in the DeFi space to be prepared for any potential attacks.
  • Use a trusted platform. Only use platforms that have been thoroughly vetted by the community.
  • Don’t put all your eggs in one basket. Diversify your portfolio so that you’re not reliant on anyone’s platform or protocol.
  • Monitor your positions. Keep an eye on your positions and be prepared to exit if something doesn’t seem right.
  • Stay informed. The best way to prevent flash loan attacks is to stay informed about the latest developments in the DeFi space.

The risk of flash loan attacks is something that the DeFi community is aware of, and there are a number of ways to prevent them. You can minimize the risk of being attacked by using decentralized exchanges, non-custodial wallets, and decentralized lending platforms. And by staying informed about the latest developments in the space, you can be prepared for any potential attacks.

Conclusion

When it comes to crypto, security is paramount. A single hack can result in the loss of millions of dollars worth of digital assets. That’s why it’s important to be aware of the various types of attacks in the crypto space. One such attack is the flash loan attack. To prevent a flash loan attack from happening, it’s important to understand how they work and what measures can be taken to mitigate them.

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FAQ

What is a flash loan?

A flash loan is a short-term, high-interest loan that allows borrowers to access large sums of cash quickly and easily. Banks often use flash loans to cover unexpected expenses or to take advantage of opportunities that require quick action.

What is a flash loan attack?

A flash loan attack is a type of exploit that allows a hacker to borrow money from a lending platform and then use that money to manipulate the platform’s price data. This can be done by buying or selling assets on the platform or transferring funds out of the platform altogether.

How do flash loan attacks happen?

There are a few ways that flash loan attacks can happen. The first way is if the attacker has access to the smart contract code. This type of attack is called a “reentrancy” attack. The second way is if the attacker can exploit a flaw in the smart contract code to get more money than they should have. This type of attack is called an “underflow” or “overflow” attack. The third way is if the attacker can find a way to get the money out of the smart contract before it expires. This type of attack is called an “exit scam.”

What are the consequences of flash loan attacks?

The consequences of flash loan attacks can be devastating. They can lead to the loss of funds, the theft of data, and the destruction of reputations. In some cases, they can even lead to the death of innocent people.

How to prevent flash loan attacks?

While there is no surefire way to prevent flash loan attacks, there are a few measures that can be taken to minimize the risk:

– Limit the amount of money that can be borrowed in a single flash loan.

– Require collateral for flash loans.

– Force liquidation of collateral if the loan is not repaid.

– Improve transparency and monitoring around flash loan activity.

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