Enabling Real-World Data in Smart Contracts
Since Bitcoin's creation in 2009, blockchain technology and the crypto space have made major advances, leading us to a now rapidly growing and diverse ecosystem of public blockchains, decentralized applications (dApps), DeFi, and cryptocurrencies. These innovations have changed the way we transact and interact with digital assets.
Smart contracts are self-executed computer programs designed to run autonomously when predefined events or actions occur: with the right inputs, a certain output is guaranteed. The terms of a smart contract are specified in code, thus eliminating the need for human intervention, third-party services or a single entity, and leveraging objectivity and automation.
Despite their numerous use cases, there is something blockchain-based smart contracts can't do: they can't interact with the outside world. This is where blockchain oracles come in.
What are Blockchain Oracles?
Blockchain oracles provide a way for smart contracts to access real-world data sources, creating a link between blockchain networks and the outside world. They are regarded as blockchain middleware.
These data sources can be information such as weather data, exchange rates, market prices, and more. In use cases such as supply chain management, prediction markets, derivatives, and decentralized finance (DeFi) applications, this real-world data is critical.
Although Ethereum is one of the most popular blockchain networks for smart contracts, and has a thriving ecosystem of oracles, oracles aren't limited to ETH. Other blockchains can use decentralized oracle services provided by some blockchain oracle projects: Chainlink, for example, has enabled cross-chain communication, allowing smart contracts on different blockchain networks to interact with each other.
Types of Oracles
There are two types of blockchain oracles: inbound oracles and outbound oracles.
Inbound oracles bring external data into the blockchain network, while outbound oracles send on-chain data to external systems. Generally speaking, each type of oracle involves a combination of fetching, validating, computing upon, and delivering data to a destination. Any device or entity that connects a deterministic blockchain to off-chain data is referred to as a blockchain oracle. Oracles use tools such as APIs, SDKs, IoT sensors, or other sources to collect data.
There are also different types of oracles based on their functionality:
Software oracles: These are the most common type of oracle, and they rely on Application Programming Interfaces (APIs) to access external data sources.
Hardware oracles: These oracles use physical devices, such as Radio Frequency Identification (RFID) tags, to collect data from the external world.
Computation oracles: These oracles perform off-chain computations and then send the results to the blockchain network.
Human oracles: These oracles rely on human input to provide data to the blockchain network.
Centralized and Decentralized Oracles
One of the main challenges of blockchain oracles is the Oracle Problem. This refers to the issue of trust in the data provided by the oracle.
Centralized oracles rely on a single source of data, which creates a single point of failure and counterparty risk, which isn't ideal for a trustless ecosystem like blockchain. The fundamental issue with centralized oracles is that because they have a single point of failure, they make contracts more vulnerable to attacks and weaknesses, and a bad actor's intervention could directly affect the smart contract.
Decentralized oracles aim to minimize counterparty risk, similarly to public blockchains. Decentralized oracles are also known as consensus oracles, because the smart contract consults several oracles to assess the data's validity and accuracy. A Decentralized Oracle Network combines multiple independent oracle node operators and multiple reliable data sources to establish end-to-end decentralization.
Chainlink is one of the most widely used oracle providers, offering secure and reliable access to off-chain data sources. It aggregates data from multiple data providers, ensuring a more accurate and reliable data feed. Decentralized exchanges that run on a shared protocol can provide price feeds for assets such as ether (ETH) and bitcoin (BTC). However, they have no way to access the current price of ether or bitcoin in terms of fiat. This is where decentralized oracles such as Chainlink come and and provide the exchange with a price feed. Many other blockchain projects such as Band Protocol, Augur and MakerDAO have developed.
Blockchain Oracles Use Cases
Blockchain oracles have numerous use cases in the real world. In supply chain management, they can be used to track the movement of goods and ensure the authenticity of products. Prediction markets use oracles to settle bets based on real-world events, such as election results or sports scores. DeFi applications rely on oracles to provide real-time price feeds for cryptocurrencies and other digital assets. NFTs can also benefit from oracles, as they can verify ownership and transfer of unique digital assets.
As blockchain technology continues to evolve, the need for reliable and trustless data sources will continue to increase, and so will possible use cases. Decentralized oracle networks will continue to play a crucial role in ensuring the interoperability and security of blockchain-based systems.