Use Cases for Flash Loans in DeFi: Arbitrage, Liquidations, and More

Flash loans don’t need collateral. They don’t require credit checks. And they vanish if you don’t pay back in the same transaction. Sounds impossible? That’s the point. In traditional finance, borrowing $1 million without putting up a dime would get you locked up. In DeFi, it’s just a few lines of code - and it’s happening every minute on Ethereum and other chains.

How Flash Loans Actually Work

A flash loan is a single blockchain transaction that borrows money, does something with it, and repays it - all before the block is finalized. If any part fails, the whole thing rolls back like it never happened. No one loses anything. No one gets paid. The system stays balanced.

This works because of atomicity: the blockchain treats the entire sequence as one indivisible unit. You can’t have half a transaction. So when you take out a $500,000 flash loan in DAI, you must return it - plus a small fee - within the same block. If you don’t, the network cancels everything. No debt. No loss. No trace.

The most common platforms for flash loans are Aave, Uniswap, and Balancer. Aave handles over 60% of all flash loan volume. Their fee is just 0.09%. Uniswap calls theirs “flash swaps,” and they let you pull tokens first, then pay later - same rules, slightly different mechanics.

Gas costs vary. On Ethereum, a typical flash loan costs between $10 and $30 in ETH fees. During peak times, that can spike to $80 or more. That’s why most profitable flash loan users wait for low congestion or move to Layer 2 networks like Polygon or Arbitrum.

Use Case #1: Arbitrage Between Exchanges

This is the biggest use case - and it’s why flash loans exist in the first place.

Imagine this: ETH is trading for $3,200 on Uniswap but $3,220 on SushiSwap. That’s a 0.6% difference. In traditional markets, you’d need capital, time, and order routing to exploit this. In DeFi? You can do it in 15 seconds with a flash loan.

Here’s how:

1. Borrow $500,000 in DAI via Aave.
2. Swap that DAI for ETH on Uniswap at $3,200.
3. Immediately swap the ETH back to DAI on SushiSwap at $3,220.
4. Repay the $500,000 loan + 0.09% fee ($450).
5. Keep the profit: around $2,600.

You didn’t risk your own money. You didn’t wait for settlement. You didn’t need to deposit collateral. You just used the market’s inefficiency - and vanished with the profit.

In Q1 2024, professional traders reported over 140 profitable arbitrage operations using flash loans, netting $187,000 in profit with zero personal capital at risk. That’s the power of speed and automation.

Use Case #2: Collateral Swaps and Liquidations

DeFi lending platforms like Aave and Compound require borrowers to over-collateralize loans. If the value of your collateral drops too much, your position gets liquidated.

Flash loans make liquidations faster, cheaper, and more efficient.

Say someone borrowed $100,000 worth of DAI using ETH as collateral. The ETH price crashes. Their loan is now undercollateralized. A liquidator can step in.

Instead of using their own cash to buy the collateral, they use a flash loan:

1. Borrow $100,000 in DAI via Aave.
2. Use that DAI to buy the undercollateralized ETH from the borrower’s position at a discount.
3. Repay the DAI loan + fee.
4. Keep the ETH - now worth more than the repayment amount.

This is how liquidators make money without tying up capital. And it’s critical for keeping DeFi lending markets healthy. Without flash loans, liquidations would be slower, riskier, and less frequent - leading to more bad debt.

According to Aave’s 2023 report, 26.1% of all flash loans were used for liquidations. That’s over $4 billion in volume last year alone.

Use Case #3: Self-Collateralization and Debt Refinancing

Some users use flash loans to restructure their positions without selling assets.

Let’s say you have a $200,000 loan on Compound, backed by WBTC. You want to switch to Aave because their interest rate is lower, but you don’t have the DAI to pay off your Compound loan.

Here’s the move:

1. Borrow $200,000 in DAI via flash loan.
2. Use it to repay your Compound loan.
3. Withdraw your WBTC collateral from Compound.
4. Deposit that WBTC into Aave as collateral for a new loan.
5. Repay the flash loan.

You’ve lowered your interest rate. You kept your WBTC. You didn’t sell anything. And you didn’t need extra cash.

This is especially useful during volatile markets. If you’re afraid of selling your crypto during a dip, flash loans let you move your debt without touching your assets.

Use Case #4: Multi-Protocol Trading Strategies

Flash loans unlock combinations that would be impossible otherwise.

For example: you can borrow DAI, swap it for USDC on Uniswap, lend that USDC on Aave to earn interest, then use that interest to buy more DAI - and repay the original loan - all in one transaction.

Or: you can borrow ETH, use it to provide liquidity on a new AMM, earn trading fees, and repay the loan before the block closes.

These aren’t theoretical. Developers on GitHub have built over 1,200 flash loan projects. The most popular template, Aave’s flash-loan-demo, has been forked over 900 times. Many of these are automated bots running 24/7, scanning for tiny price gaps across 10+ protocols at once.

One Reddit user, u/DeFiArbMaster, spent three months learning Solidity before executing their first successful $250,000 arbitrage. They netted $8,350 after fees. “The learning curve was brutal,” they wrote. “But once it worked, I knew I’d found something real.”

The Dark Side: Flash Loan Attacks

Flash loans aren’t just for profit. They’re also weapons.

In 2023, flash loan attacks caused $247 million in losses - the second most common DeFi exploit vector, according to OpenZeppelin. Here’s how they work:

1. Attackers borrow millions in DAI via flash loan.
2. They dump it on a small DeFi pool, crashing its token price.
3. They use the manipulated price to borrow more of another asset at a fake low rate.
4. They withdraw the asset and vanish - leaving the protocol with worthless collateral.

The Harvest Finance exploit in 2020 lost $30 million this way. It happened because the protocol didn’t properly validate price feeds.

Since then, protocols have added safeguards: price oracles from Chainlink, flash loan filters (Aave v3.1), and contract whitelists. But attackers keep evolving.

Aave’s founder, Stani Kulechov, says 78% of flash loans are legitimate. But Chainalysis estimates 22% are malicious - including 14% in arbitrage-based manipulation and 7.5% in money laundering.

The Financial Action Task Force (FATF) flagged flash loans in June 2023 as a potential money laundering tool. The SEC has already taken action against platforms using flash loans for pump-and-dump schemes.

Who Can Use Flash Loans?

Flash loans aren’t for beginners. You can’t just log in and borrow.

You need:

• A working knowledge of Solidity (Ethereum’s programming language)
• A smart contract that interacts with Aave or Uniswap’s flash loan interface
• A testnet to debug before going live
• Real-time monitoring tools like Tenderly or DeFi Saver
• Gas fee awareness - you can’t afford to lose $50 on a failed try

Most successful users spent 3-6 months studying before their first profitable trade. One Reddit user, u/CryptoNoob2023, lost $1,200 in gas fees over weeks of failed attempts because they forgot to implement the receiveETH() function properly.

Professional traders use flash loans like a scalpel - precise, fast, and only when the opportunity is clear. They don’t gamble. They calculate. They automate. They wait.

The Future of Flash Loans

The technology is evolving fast.

Aave’s v3.1 introduced flash loan filters - allowing protocols to block unknown contracts. Over 60% of major DeFi platforms have adopted this by mid-2024.

Uniswap v4, launching in late 2024, will reduce gas costs by 15-20% with a new “flash accounting” system. That could make small arbitrage opportunities profitable again.

Cross-chain flash loans are coming. Today, most happen on Ethereum. But in 2025, we’ll see them across Polygon, Arbitrum, Base, and even Solana via bridges. Messari predicts 40% of flash loan volume will be cross-chain by then.

Regulation is catching up. The EU’s MiCA rules now classify flash loans as a crypto-asset service - meaning platforms offering them may need licenses. The U.S. SEC’s $2.1 million fine against a flash loan arbitrage bot in February 2024 signals they’re watching closely.

And in the long term? MIT researchers suggest zero-knowledge proofs could enable private flash loans by 2026 - letting users execute complex trades without exposing their strategy to the public chain.

Final Thoughts

Flash loans are not magic. They’re not free money. They’re not a get-rich-quick scheme.

They’re a tool. A powerful, fast, and dangerous one.

Used right - they keep DeFi markets efficient, punish bad actors, and enable capital to flow where it’s needed most.

Used wrong - they’re a weapon that can drain millions from protocols in seconds.

The best use cases aren’t flashy. They’re quiet. They’re calculated. They’re the ones that make markets fairer - not just richer.

If you’re thinking about trying one: start small. Learn Solidity. Test on Goerli. Watch gas prices. And remember - if you don’t repay in the same block, it all disappears. Just like it never happened.