Brainstorm on Flash Loans, Failures, and the Future of Finance
On March 6, IDEO CoLab Ventures and experts including Camila Russo, Max Wolff, Tina Zhen, and 50+ others from around the world brainstormed the emergence of flash loans, recent contract failures, and the impact these instruments will have on the future of finance. You can watch the full video here and check out the twitter thread here.
At IDEO CoLab Ventures we’ve been experimenting with new formats for collaborative virtual brainstorms in order to work with experts wherever they are, and share live sessions with people from around the world. Our second interactive session focused on the emergence of flash loans in DeFi, and brought together experts with a variety of perspectives, including Camila Russo (The Defiant), Max Wolff (Compound), and Tina Zhen (honeylemon.market).
What are Flash Loans?
Flash loans are a new primitive in the DeFi ecosystem that essentially give instant access to massive amounts of capital to exploit arbitrage opportunities within the same block. In other words, flash loans give borrowers instant, near-infinite credit, as long as the lender is guaranteed to be paid back immediately.
People are especially drawn to flash loans because they are only available in a blockchain-based financial system, and they enable anyone to instantly collapse arbitrage opportunities that, historically, they wouldn’t have been able to access. When anyone can be a whale for an instant, this will immediately surface and exploit new risks for projects and protocols across the board. However, in the long term, flash loans are a crypto-only primitive that will force the DeFi builders to improve contract design, market mechanisms, and overall system security.
What Makes Flash Loans Interesting?
Our panel had a variety of thoughts about what makes flash loans interesting. Camila spoke to the fact that they enable people to do really sophisticated strategies without having to be big investors. In the past, these types of arbitrage opportunities were restricted to traders with lots of capital, but now the barriers of entry to flash finance are gone. This is also explored in-depth in Haseeb Qureshi’s piece on flash attacks.
Tina, who has a keen perspective on infrastructure, likes these instruments because she believes they can be used to create new structured DeFi products for the rapidly evolving mining ecosystem. And Max talked about how unique it is that we can now connect various financial protocols together, in ways native to cryptocurrency, without the need for any formal integration. For example, the designer of financial Protocol A doesn’t have to know about Protocol B, or account for it in their design. However, someone can come along to connect these two protocols in a powerful and unexpected way to create a new financial stack.
What Does Flash Loan Protection Look Like?
If 2019 was the year of curating yield, 2020 will be the year of curating risk.
- Tina Zhen
To get us thinking about protecting participants and protocols from new risk vectors, each panelist offered their thoughts on possible measures or heuristics we can use. To start us off, Camila pointed out that flash loans immediately expose the bad behaviors we’ve been leaning on to bootstrap our networks. Specifically, she referred to the use of DEX spot prices as oracles; the practice that enabled the recent bZx exploit.
Taking this idea one step further, Tina suggested that we move to oracles that are based on time-weighted average pricing (TWAP), and urged caution when dealing with low liquidity assets. And coming at it with an engineering lens, Max issued a word of caution to any DeFi developer specifically mentioning that anytime you have a protocol that can make permanent changes to a user’s balance, the risk is increased and you need to be extremely careful.
Creative Tensions: Flash Loans
Creative tensions is an exercise developed by IDEO and Sundance as a way to quickly and interactively learn where people stand in an issue. Usually done as an in-person exercise, we took this to Figma so in an effort to experiment with involving everyone who registered.
Here’s how it works:
- A question is asked and two possible answers are selected that create opposing poles on a spectrum.
- Participants take a virtual post-it note, and place it somewhere on that spectrum to represent where they fall with respect to the question (normally, individuals would position themselves in physical space).
It’s pretty simple in practice. To get people warmed up, we asked the crowd if they were more of a Cat Person or a Dog Person. Looking below, we can see that while the audience contained a few Cat People, the audience skewed more towards being Dog People (note: the subtle awesomeness of cats is beyond the scope of this blog post).
For our second question, on the heels of some major DeFi protocols being exploited, we asked if people thought flash loans were more Helpful or Harmful. Group responses to this question showed that even with all of the newly emerging short-term risk, people generally believe that flash loans are a helpful primitive for a variety of reasons — some of which were covered above.
Next, we asked people if they thought that arbitrage with flash loans would be a profitable long-term strategy. It turns out that while a few people think they are lucrative in the short to medium term, most people think the space will evolve into a high-frequency competition that yields diminishing returns.
Finally, we asked people what percentage of DeFi funds they considered to be at risk to flash loan-based exploits. What’s interesting to note here is that the group contained more optimists (those who believe less than 50% of capital is at risk) than pessimists. But while the spread of the optimists was relatively wide (below the 50% marker), the pessimists nearly uniformly believed that a majority of funds are at risk.
We want to thank all of our participants, panelists, and the whole @IDEOVC team who helped make this a great event. If you want to chat with us more about this topic or are working on a new project/startup in the DeFi space, follow us at @IDEOVC and drop us a line at startups@ideo.com.
Don’t miss our next virtual brainstorm “Banking for the Next Billion Users” on Wednesday, March 25 at 9am PST. Register here: https://tinyurl.com/cryptonext
