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This is what oracles mean for the crypto economy

4 min read

What do weather forecasts and crypto courses have in common? You depend on reliable data sources. Blockchain networks are closed systems. Information about transactions and smart contracts is transparent for all network participants, but no information can penetrate from outside. This is exactly where oracles come in.

Because oracles are independent computer programs, also called agents, that supply blockchain networks with external data. These can be rates of crypto currencies or even measured values ​​from weather stations. Oracles are integrated into smart contracts using so-called multi-signature contracts. These must be signed by all contractual partners and can depict simple to complex if-then structures.

Five Oracle types

There are five types of oracles. Oracle software transmit data that is available online, for example flight cancellations or weather data. Hardware oracles forward information from the “real world”, for example data from RFID sensors to control supply chains.

Inbound oracles supply blockchains with external data such as real-time rates while Outbound oracles enable the transfer of data in the opposite direction: Smart contracts send information outwards. at Consensus Based oracles are several oracles connected to one another in order to create a consensus of independent data providers.

Essential for smart contracts

Oracles have a special function for smart contracts. Smart contracts are initially nothing more than simple, self-executing contract structures under certain conditions: If it was specified in the smart contract that person A transfers money to person B when event X occurs, then the smart contract is also triggered when event X occurs.

This works well on a simple level, as in the example of a loan between two contractual partners. Event X could be a pre-arranged date. But what if the triggering of a smart contract is linked to several conditions?

The more complex, the more error-prone

The more information from the real world is needed to revive a smart contract, the more error-prone smart contracts are. And the more capital they move, the more serious the mistakes can be.

An example: As weather insurance, a smart contract organizer compensates for thunderstorms. The contract requires measured values ​​for this. If incorrect information is passed on, considerable financial damage could result for both the insurance company and the insured person.

Not a panacea

So where oracles solve important problems, they also create new ones. Oracles are only as good as the data sources used – and most of them are man-made. Manipulations or incorrect data can also not check oracles. Thus, oracles unearth a problem that blockchain technology actually wanted to solve: trust dependency. If you access external data, you also have to trust the data provider. So do oracles hollow out the “trustless” command in crypto space?

Not necessarily. Oracle vendors are working on various solutions to circumvent the problem. Consensus based oracles are an approach to minimize the likelihood of incorrect data. Another comes from the Oracle network Chainlink.

Chainlink: The oracle for DeFi

Chainlink is a network of nodes that feeds “off-chain data” into smart contracts via oracles and thus represents an important support for many applications in the field of decentralized finance (DeFi). That’s what counts right now Chainlink ecosystem Over 700 integrations and partnerships, the best known being the DeFi protocols Aave and Synthetix.

If a smart contract needs certain information, they send a request (requesting contract) to the Chainlink protocol. Chainlink processes the request as a new smart contract (SLA contract) that contains three subcontracts.

The Chainlink Reputation Contract selects nodes based on their trustworthiness. Nodes increase their reputation by passing on correct data, unreliable oracles are thus displaced. The Chainlink Order-Matching Contract transmits the request to the relevant nodes. The Chainlink Aggregating Contract finally compares the results of the oracles with one another. The data is fed back to the Chainlink protocol via an API.

It doesn’t work without trust

Nodes are paid for their work with LINK tokens. In addition, the crypto currency serves as security: Node operators have to deposit LINK as a deposit. If they behave incorrectly, they put their invested capital at risk, and high and honest participation is in turn rewarded with LINK tokens.

Although Chainlink ensures natural selection with the reputation system, it cannot completely avoid the trust problem. The human predetermined breaking point always remains, even if it minimizes the susceptibility to manipulation. Nevertheless, Chainlink’s Oracle network performs an important function for the interoperability of blockchain networks, without which many DeFi applications would not even be possible.

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All content in this article is for informational purposes only and in no way serves as investment advice. Investing in cryptocurrencies, commodities and stocks is very risky and can lead to capital losses.

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