Understanding Flash Loan Attacks: A Deep Dive into DeFi Vulnerabilities | Markdown Memoirs

Understanding Flash Loan Attacks

Flash loans are a groundbreaking innovation in decentralized finance (DeFi), offering users access to large amounts of liquidity without requiring collateral. While they enable legitimate use cases, such as arbitrage and liquidation, they also pose significant risks to decentralized autonomous organizations (DAOs) and governance systems. This article explores how flash loans work, their potential for exploitation, and how they can be used to attack governance mechanisms.

What Are Flash Loans?

Flash loans are uncollateralized loans that must be borrowed and repaid within the same blockchain transaction. If the loan is not repaid by the end of the transaction, the entire operation is reverted. Some common legitimate use cases include:

Arbitrage opportunities between decentralized exchanges.
Liquidating undercollateralized positions.
Complex financial operations requiring large capital.

However, their instantaneous nature also makes them a powerful tool for malicious actors to exploit vulnerabilities in governance systems.

How Flash Loans Exploit Governance Systems

Governance systems in DAOs often rely on token-based voting mechanisms. Token holders can propose and vote on actions, with decisions typically based on the number of tokens held. Flash loans allow attackers to temporarily acquire a majority of governance tokens, manipulate proposals, and execute malicious actions — all without long-term ownership.

Steps in a Governance Attack

Borrow Tokens: Use a flash loan to borrow a significant amount of governance tokens.
Manipulate Voting Power: Temporarily gain majority control over token-based voting.
Propose Malicious Action: Queue an action that benefits the attacker (e.g., draining funds).
Execute Action: After fulfilling any time delays or prerequisites, execute the proposal.
Repay Loan: Return borrowed tokens within the same transaction.

Easy Example: Damn Vulnerable DeFi Challenge #6 ("Selfie")

The "Selfie" challenge from Damn Vulnerable DeFi demonstrates how flash loans can exploit governance systems. Here's a simplified breakdown of how attackers can drain funds from a vulnerable lending pool:

Challenge Overview

A lending pool offers flash loans of DVT tokens.
Governance mechanisms control the pool's operations.
The goal is to drain 1.5 million DVT tokens from the pool.

Vulnerability

The governance contract allows any token holder with at least 50% of the token supply to propose actions. Flash loans enable attackers to temporarily acquire this majority.

Key Code Snippet

The vulnerability lies in how voting power is determined:

function _hasEnoughVotes(address account) private view returns (bool) {
    uint256 balance = governanceToken.getBalanceAtLastSnapshot(account);
    uint256 halfTotalSupply = governanceToken.getTotalSupplyAtLastSnapshot() / 2;
    return balance > halfTotalSupply;
}

Attackers exploit this by taking a snapshot after borrowing tokens via flash loan, temporarily meeting the voting threshold required to queue malicious proposals.

Mitigating Flash Loan Attacks

To secure DAOs against flash loan attacks, developers must implement robust governance mechanisms:

Token Locking: Require tokens to be locked before voting eligibility.
Time-Locked Proposals: Introduce delays between proposal submission and execution.
Snapshot Validation: Ensure snapshots are taken before proposals are submitted or votes cast.
Voting Weight Caps: Limit voting power per address or use quadratic voting mechanisms.
Monitoring Systems: Deploy tools to detect unusual activity and respond swiftly.

Conclusion

Flash loans are both a powerful financial innovation and a significant security risk for DAOs and governance systems. Understanding their mechanics and vulnerabilities is crucial for designing secure protocols that resist exploitation. Challenges like "Selfie" provide valuable insights into these attacks while emphasizing the importance of secure governance mechanisms.