Flash Loan: the DeFi mechanism that turns into a nightmare in just a few clicks

The Mechanics Behind Billions at Risk

A Flash Loan is a revolutionary financial instrument in DeFi: it allows borrowing massive sums — with no collateral — provided that the entire amount is repaid within the same blockchain transaction. If this condition fails, the entire operation is instantly canceled, as if nothing happened.

It is precisely this flexibility that appealed to developers. For arbitrage, refinancing, or liquidations, Flash Loans represented an elegant tool. But the same property — the lack of checks during execution — has opened the door to a category of devastating attacks.

How Does a Flash Loan Attack Occur?

The scheme has become sadly classic:

Step 1: The attacker takes out a colossal flash credit (say 10 million USDC from a lending platform)

Step 2: These suddenly injected funds destabilize prices on a DEX — the temporary concentration of capital skews pricing calculations

Step 3: On another protocol relying on these distorted price data, the attacker makes unjustified withdrawals of valuable assets

Step 4: The initial loan is repaid (minus transaction fees), and the attacker disappears with the difference — all in a fraction of a second

No trace, no recourse.

Major DeFi Crashes: When Algorithms Failed

The bZx incident (February 2020): The first real warning. One million dollars vanished when an attacker manipulated collateral price indices.

Harvest Finance theft (October 2020): 34 million USDC and USDT evaporated in minutes. The protocol’s price oracles, too naive, could not withstand liquidity pool manipulation.

The PancakeBunny catastrophe (May 2021): 45 million dollars in losses. This time, the target was the governance token BUNNY itself, whose price was artificially collapsed.

These three examples only scratch the surface — hundreds of other attacks have struck quietly.

Why Do Protocols Remain Vulnerable?

Three structural flaws recur systematically:

1. Poorly secured price oracles — Data sources used to value assets are often too simplistic, relying on a single liquidity pool that can be flooded with malicious capital.

2. Over-trusting smart contract logic — Many smart contracts assume input data is reliable, without independent verification.

3. Lack of temporal safeguards — No delay exists to distinguish normal prices from manipulated short-term prices.

Existing Defense Technologies

For DeFi protocols, several shields have proven effective:

• Reputable decentralized oracles (Chainlink leading the way) provide an external verification layer, much more robust than internal oracles
• Time-weighted average prices (TWAP) — instead of considering the instantaneous price, they average quotes over a period — making ephemeral manipulations useless
• Multisignatures for critical operations — requiring multiple approvals slows down parameter changes
• Regular external audits — verifying code logic before deployment reduces errors

Practical Tips for Users

No need to be a developer to protect yourself:

1. Limit investments in unaudited protocols — if the code hasn’t been validated by independent third parties, prefer reduced exposure
2. Stay informed about incidents — enable security notifications, follow audit reports
3. Favor proven platforms — older, widely used protocols have had more time to fix vulnerabilities
4. Withdraw funds after an incident — if a hack is confirmed, even minor, it’s a signal to exit while awaiting verification

Conclusion: Manage Risk, Not Eliminate It

Flash Loans remain a remarkable innovation in blockchain — they offer instant liquidity without collateral, enabling legitimate use cases. But like any powerful technology, they require risk management.

Attacks will likely continue to occur. The goal is not to prevent them entirely but to build protocols robust enough to render them ineffective. And for users, to choose DeFi partners wisely — prudence remains the best investment.