Introduction to oracles: how different DeFi protocols have brought in billions of dollars without centralization. | by ADEGBITE MUBARAQ | Synchrony | June 2022

Over the past two years, the DeFi industry has grown exponentially. The Ethereum blockchain and its smart contracts, which are self-executing agreements that eliminate the need for a third party, deserve a lot of credit for the remarkable development of DeFi. However, there is another crucial piece of the infrastructural structure that enables DeFi expansion. Who are – Oracles.

In medieval times, an oracle was a person who claimed the ability to see into the future and gave useful information to someone who needed it.

This is how it works in the blockchain space with a small change from a technology standpoint.

Simply put, an oracle is a trusted third party that provides you with reliable data apart from current information that you have access to. It is software that acts as an intermediary helping to perform two-way data transfer between smart contracts (on-chain) and the real world (off-chain).

Examples of data passed from oracles to smart contracts include price information, payment success, temperature measured by a sensor, election results, and more.

how oracle works

Let’s dive deeper,

Blockchain oracles can be categorized into three sectors:

  1. Source: Is it from software data or hardware data?
  2. information department: Is this data incoming or outgoing?
  3. The degree of trust: Is the data centralized or decentralized?

Using the classification above, we can now differentiate the different types of blockchain oracles.

Hardware Oracles

Hardware oracles collect data directly from the physical world and convert it into numerical values ​​that can be incorporated into smart contracts. These include barcode scanners and sensors that actively or passively collect data and transmit it to the smart contract.

Oracle software

Software oracles obtain information from online sources, browse their websites and thus provide the latest information to the smart contract. For blockchains, this information usually comes from cryptocurrency exchanges.

Incoming Oracles

Inbound oracles allow the network to send information from external data sources to smart contracts.

Outgoing Oracles

Outbound oracles allow smart contracts to send data to external sources.

Centralized Oracles

A centralized oracle is a single entity that provides data from an external source to a smart contract protected by a set of security protections. However, since there is only one node in charge – comparable to a traditional financial system with a single point of failure – the smart contract becomes less secure and more susceptible to corruption and attack by bad data on it. are provided.

Decentralized Oracles

Some of the goals of decentralized oracles are similar to those of public blockchains, such as minimizing counterparty risk. They make the information provided to smart contracts more reliable by not depending on a single source of truth. The smart contract consults a number of oracles to assess the validity and accuracy of the data; this is why decentralized oracles are also called consensus oracles.

Other blockchains may use decentralized oracle services provided by some blockchain initiatives. In prediction markets, where the authenticity of a specific outcome can be verified by social consensus, decentralized oracles can be valuable.

Human Oracles

People with specialized knowledge in a specific industry can sometimes act as oracles. They can collect information from various sources, verify its legitimacy and convert it into smart contracts. Since human oracles can use cryptography to verify their identity, the chances of a fraudster impersonating them and giving falsified data are slim.

Why are decentralized oracles needed in the DeFi ecosystem?

Oracles are intermediaries that ensure trust in the DeFi ecosystem.

To begin with, decentralized oracles are mostly used within the DeFi ecosystem, as the use of centralized oracles goes against the concept of DeFi products/applications. DeFi applications are financial solutions based on blockchain technology.

Take this example,

Imagine that Andy and Cozy bet on the weather. Andy thinks it will be a rainy week, while Cozy thinks it will be a sunny week. They agree on the terms of the bet and lock their funds in a smart contract, which will release all funds to the winner based on the results of the weather.

Since the smart contract cannot interact with external data, it must depend on an oracle to provide it with the necessary information – in this case, weather results. Once the day is over, the oracle asks a API (application programming interface) to know what weather forecasts are happening and pass this information to the smart contract. The contract then sends the funds to Andy or Cozy, depending on the outcome.

Without the oracle relaying the data, there would have been no way to settle this bet in a way that could not be played by any of the participants.

This is why oracle is needed in DeFi and cryptocurrency because it solves centralization and trust issues.

ChainLink: The oracle of all oracles.

Chainlink is a decentralized network of oracles that allows smart contracts to securely communicate with real-world data and services outside of blockchain networks. With Chainlink, the existing technologies currently powering modern economies can connect with the growing blockchain industry to improve the security, efficiency, and transparency of business and society operations.

The Chainlink decentralized oracle can connect many different types of data with many different blockchains, creating many potential applications for Chainlink. Chainlink could help bring blockchain technology to many industries and business functions.

Chainlink aims to continue its growth by expanding its support for blockchain environments and facilitating new use cases for hybrid smart contracts. Since large stores of data and records are not yet held on blockchains, Chainlink may have countless opportunities to connect blockchain networks with off-chain information.

Malicious hackers who aim to exploit price anomalies by targeting oracles are vulnerable to attacks against blockchain oracles. Oracles are vulnerable to these attacks because they are meant to be outside the blockchain consensus mechanism, and therefore blockchain security guarantees do not apply to them.

Platforms like Chainlink are at the forefront of Oracle’s development. Chainlink has partnered with industry titans including Google, Oracle Corporation, Gartner, Binance, and even China’s Blockchain Service Network to improve the application of oracles in blockchain.

Chainlink currently holds the top spot among oracles, with its network securing over $75 billion in smart contract value.

Chainlink secures tens of billions of dollars across major DeFi, lending, and gaming protocols, as well as many chains in the blockchain industry. Chainlink secures up to 90% of the value of certain DeFi-focused chains within dApps.

Chainlink’s oracle infrastructure, a platform-agnostic chain with its own native Top 20 (LINK) asset, comprises a Sybil-resistant network of independent oracle nodes that fetch data from a variety of off-chain sources , before aggregating the data off-chain and delivering it on-chain for consumption by smart contracts.

Nest Protocol: the two-way rating mechanism.

The NEST protocol is a distributed pricing oracle network based on the Ethereum mainnet. It uses a unique “quote mining” technique to ensure that the on-chain creates off-chain price information in parallel. The NEST protocol generates price data directly on the blockchain, addressing the lack of price data on the blockchain.

Nest Protocol, a blockchain oracle that provides a unique and secure way to receive actual pricing data in the DeFi ecosystem, has released an ERC-20 token called NEST. In 2020, the Nest Protocol was released. The Nest protocol differs from other oracles in that it uses an authentication scheme. The listing is first submitted to a miner for verification, along with a processing fee in ETH and listed assets in an appropriate proportion.

For example, if a miner declares that 1 ETH is equal to 100 USDT, he must enter into a smart contract with the price and commit 1 ETH and 100 USDT. The asset will then be swapped or left alone if there is an arbitrage opportunity. The price is included in an on-chain price block in the latter situation. The miner can withdraw their assets from the contract when the verification time is up. The portion of fees that Oracle customers pay for their data requests goes to miners and “verifiers.” Because arbitrage requests are rejected, miners are rewarded for offering prices as close to the real market as possible; otherwise, they would lose both the commission and the submission fee. In-network payments are made in NEST, which also functions as a governance token, in addition to these processing fees. In-network payments are made in NEST, which also functions as a governance token, in addition to these processing fees. offer prices as close to the real market as possible, otherwise they will lose both fees and profits.

If you are curious and want to learn more about the Nest protocol — go here

In summary

Decentralized finance clearly relies on more than just blockchain, with smart contracts and oracles serving as two essential components. Individual initiatives must, of course, create applications that people want to interact with.

Although speculation has been the most common DeFi use case so far, the emergence of gamified finance, along with blockchain-based insurance, prediction markets, governance, supply chain and digital identification, point to a bright future.

Teams that ignore the importance of oracles could suffer a nasty shock.

Having a reliable data stream is essential for long-term success. Data service companies that ignore oracles risk losing their Web3 existence.


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