Blockchain technology, with its inherent characteristics of immutability, transparency, and shared ledger, is poised to play a transformative role in shaping the future of our society. Its potential as a disruptive alternative to legacy systems has gained considerable traction across various industries. Additionally, its applicability transcends the realm of cryptocurrency, presenting opportunities for implementation in diverse sectors such as product traceability, supply chain management, gaming, governance, healthcare, and real estate.
Blockchains and smart contracts are self-contained closed systems that can't access data external to their network. However, many contractual agreements require off-chain data to facilitate their execution.
So, how do these self-contained systems access off-chain data? The answer is Oracles.
Oracles can retrieve data from various sources, including APIs, websites, and sensors, and then provide this data to the smart contract to trigger the appropriate actions. This allows for more complex and dynamic smart contracts that can interact with real-world events and information.
Without oracles, smart contracts would have minimal use, and DeFi would not be where it is today.
Oracles are third-party services in the Web3 space that facilitate access to off-chain data for blockchains and smart contracts, bridging the gap between information inside and outside the network. Popular blockchain oracle projects include Augur, Chainlink, API3, among others.
DeFi relies heavily on oracles to provide broader access to financial applications. Many DeFi offerings, including borrowing and lending markets, prediction markets, derivatives, and insurance products, require oracles for smart contracts to respond to real-world events. Oracles facilitate smart contracts' interaction with existing data streams, legacy systems, advanced computation, and other components to carry out predefined actions. Integrating hybrid smart contracts, combining on-chain code with secure off-chain data, has significantly improved the functionality of advanced blockchain applications (dApps).
Furthermore, these contracts offer various applications across multiple industries and sectors, including insurance, agriculture, pharma, environmental sustainability, and supply chain management. Oracles are essential to almost all smart contracts that rely on real-world events.
It is important to note that blockchain oracles do not act as data sources. Instead, they authenticate, verify, and query external data, then relay the information to the enclosed network.
Oracle Use Case
Oracles have various use cases, including DeFi, supply chain management, digital identity, and insurance.
In DeFi, oracles enable algorithmic stablecoins, financial derivatives, and prediction markets to function by providing external data feeds. Supply chains can be tracked and managed using blockchain technology. Oracles can provide real-time data on shipments, inventory, and quality control to ensure the integrity of the supply chain. Oracles can also authenticate an individual's identity and collate and update personal data in digital identity solutions. Additionally, they can be used to verify the occurrence of insurable events, such as flight delays or crop failures, and automatically trigger the payment of insurance claims.
These are just a few examples of how blockchain oracles are being used to provide external data and enable various functions on the blockchain.
Let's now move on to the various types of blockchain oracles.
Different types of oracles exist with variations in their functions, validation process, and data delivery mechanisms.
Inbound and Outbound Oracles
The difference stems from the direction of an oracle's data flow.
Inbound oracles supply real-world information to smart contracts, while outbound oracles send information from smart contracts to external systems. Inbound oracles are commonly used to provide data such as weather conditions, proof of payment, and live price feeds. On the other hand, outbound oracles are used mostly by decentralized banking networks and IoT systems to send commands to off-chain systems for specific actions.
Software and Hardware Oracles
The difference originates from an oracle's data source.
For smart contract consumption, software oracles retrieve real-time information from digital sources, such as websites, online databases, and servers. Hardware oracles, in contrast, convert information from the physical world to digital values that smart contracts can process. They obtain information from electronic sensors, RFID sensors, barcode scanners, thermometers, etc. As a result, hardware oracles are essential for supply chain management.
Compute-enabled oracles provide off-chain computation solutions that are more practical than on-chain computation due to technical or financial limitations. While several Layer 2 chains utilize compute-enabled oracles, these services can also offer advanced analysis and commands for Layer 1 blockchains.
Cross-chain oracles enable interoperability between blockchains by allowing the exchange of information between different chains. These oracles allow data on one blockchain to prompt actions on another chain.
Individuals with specialized knowledge can also serve as oracles, gathering and verifying information from various sources to be converted into smart contracts. These individuals provide data feeds to a blockchain oracle, using advanced verification systems to authenticate their identity and prevent fraud.
A centralized oracle is operated by a single entity and is the only information provider for a smart contract.
These introduce a single point of failure, leaving them vulnerable to errors, manipulation, or hacking.
If a malicious actor corrupts the oracle or supplies incorrect data, the contract's security and fairness can be compromised. Moreover, relying on a single entity for accurate information can jeopardize the contract's effectiveness, compromising decentralization. Finally, while centralized oracles can be efficient, they require extra trust in the provider, contradicting the trustless nature of decentralized blockchains.
At this point, it is imperative to mention that decentralized oracles were introduced to address the challenges posed by the oracle problem. So, let's go through the Oracle Problem.
Oracles play a crucial role in facilitating the integration of external data into blockchain-based smart contracts.
However, their centralized nature poses a significant threat to the security and trustworthiness of smart contracts, as a compromised or manipulated oracle can jeopardize the entire blockchain network's integrity. This problem is compounded by the fact that relying on external data sources contradicts the decentralized and trustless principles underpinning blockchain technology.
Thus, the oracle problem presents a formidable challenge of obtaining reliable and secure data from external sources while ensuring blockchain networks' decentralized and secure nature.
To address this challenge, decentralized oracles were introduced. These oracles employ consensus mechanisms, token incentives, and multiple nodes to mitigate the risks of centralized oracles and provide reliable and accurate data to smart contracts.
Decentralized oracles solve the problem of a single source of failure. They enable increased security, reliability, and end-to-end decentralization by distributing trust among network participants.
This approach reduces counterparty risk and increases trustlessness, making it ideal for smart contracts. In addition, multiple oracles assess the data's validity and accuracy, ensuring end-to-end decentralization.
Decentralized oracles distribute trust between multiple participants to minimize counterparty risk and extend the guarantees of smart contracts. These deploy various security measures to ensure availability, correctness, and accountability. However, they are not a perfect solution, and issues like collusion, signaling, mirroring, and bribing can still occur. Therefore, it is essential to note that decentralized oracles are the accepted solution for the oracle problem but may not solve all the issues.
Till we find something better.
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