That is one of the critical drawbacks at present when it comes to the implementation of Smart Contracts in the Blockchain and Cryptocurrency Industry, which is the lack of an interaction with the external data sources. Smart contracts can only run fixed computational procedures that are embedded in, governed and executed by the chain and therefore can only call on-chain data but cannot validate off-chain data such as actual events, prices, or any form of information outside the chain.
This limitation prevents smart contracts from being as versatile as possible, and from being useful in as many scenarios as they could be.
This is where Crypto Oracles come into play Cryptocurrency If there has to be a prime mover end of the spectrum, the middle ground is held by Crypto Oracles. Crypto Oracles are platforms, which provide necessary connection between the real world and the blockchain smart contracts. They allow smart contracts to request external data and return the results of that request in a safe environment. Price feeds, weather broadcasts, musical scores, results of sports events, all sorts of signals and all sorts of data can be directly fed into blockchains by oracles.
Crypto Oracles present an innovative approach to the issue of data availability in blockchains, and thus can be most efficiently discussed as its solution. The intermediaries are responsible for procuring outside information, thereby, confirming its validity and then disseminating this information onto the blockchain.This capability greatly enriches smart contract applications and opens up broader opportunities for their use. For instance, DeFi relating to decentralized finance applications heavily depend on price oracles to feed actual rampantly price of different essentials to make operations such as lending, borrowing, and trading possible.
Payout can be based on weather oracles where weather derivatives can access and activate payouts depending on the climate conditions prevalent. In reference to the use of oracles, sports betting platforms can incorporate the physical calculations to determine bWAets based on real-time sports performance statistics. Summing it up, Crypto Oracles enable smart contracts to interface with the physical world, thus embrace numerous creative possibilities and define the further growth of blockchain technology.
The Problem With Oracle
Blockchains, by design, are closed systems. Therefore, they are unable to access or interact with data from the real world. This limitation might seem like a drawback, but it’s actually what underpins their remarkable security and reliability. That’s because blockchains are highly deterministic, and only need to reach consensus on a very simple set of questions.
These are essentially true or false questions that rely solely on data already stored within the blockchain itself. You can think of it like verifying a transaction – did the owner sign it with their private key? Does the account have enough funds? Is the transaction type valid within the smart contract? This narrow focus on internal, on-chain data verification allows blockchains to achieve a highly secure and efficient consensus mechanism, preventing double-spending attacks and minimizing network downtime. However, there’s a catch.
This isolation creates a challenge for smart contracts. To truly unlock their potential, many smart contracts need to connect with the real world. Imagine there’s a supply chain management smart contract. It can track the movement of goods within the blockchain, but it can’t verify if the goods physically arrived at their destination without external data, like sensor readings or tracking information. This inability to access external data securely is the crux of the oracle problem. Smart contracts often rely on real-world data to function properly, but blockchains themselves cannot access it.
What is a Blockchain Oracle?
This is where blockchain oracles come in. You can think of blockchain oracles as a secure bridge between blockchains and the real world. Oracles are like messengers, trusted external services that can source, verify, and transmit data from the outside world to smart contracts on a blockchain.
They enable smart contracts to interact with off-chain data and fulfill real world use cases, such as the aforementioned supply chain management. If not for oracles, the use cases for smart contracts will be substantially limited as they can only access data within its own blockchain. Oracles can transmit a variety of data such as price data, payment confirmations, and sensor measurements to name a few.
Risks of Centralized Blockchain Oracles
The big challenge for oracles, or the oracle problem, lies in making sure reliable data is fed to smart contracts without putting the blockchain’s security at risk. This is because smart contracts are designed to be self-executing and reliable, enforcing the terms of an agreement without human intervention.
The predictability of outcome is everything to a smart contract’s objective. Therefore, the underlying blockchain must not have any single point of failure, including the oracle that is feeding data into it. A smart contract on a decentralized blockchain that relies on a centralized oracle would undermine this very principle.
In this scenario, the centralized oracle will have too much influence on the outcome of the smart contract, as the input from the oracle dictates the execution of the smart contract. Even if the centralized oracle operator may not be malicious, it is still vulnerable to technical issues, cyberattacks and human error.
As the value of the smart contract or blockchain grows, this scenario becomes substantially more dangerous due to risks like bribes, censorship and regulatory pressure. This is why blockchain oracles must achieve the same security and reliability of a blockchain.
What Are Decentralized Oracle Networks (DONs)?
Through Decentralized Oracle Networks, or DONs. To understand DONs and how they work,
- Chainlink’s DONs: let’s use the leading DON in the space, Chainlink, as a case study. Chainlink doesn’t have a blockchain of its own but instead relies on a decentralized network of independent operators running Oracle nodes. The nodes collectively gather and aggregate data from a plethora of sources to transmit a validated, single data point to a smart contract. To eliminate single points of failure, Chainlink uses three layers of aggregation on many of its services. Let’s explore these layers by looking at the most demanded price oracles in the DeFi space, Chainlink Price Feeds.
The first layer is Data Source Aggregation. To ensure the data is reliable and tamper-proof, nodes will pull price data exclusively from reliable data aggregators. As data aggregators collect raw price data from various on and off-chain exchanges to generate refined datasets, the data source is refined and accounts for any abnormal deviations in the raw data.
The second layer is Node Operator Aggregation. Node operators collectively gather data from multiple independent data aggregators, then take the median value to remove outliers and account for API downtime. This bolsters the data by ensuring each price point is not only an aggregate from various exchanges, but also an aggregate from multiple data sources, further preventing any single point of failure.
The third layer is Oracle Network Aggregation. By aggregating responses from all the individual nodes in the oracle network, a single data point is created. This is usually done by taking the median of the reported values after a predefined number of responses from individual nodes have been reached. This ensures the network as a whole maintains high uptime and is resistant to data corruption during its delivery, even in the event of nodes or data sources going offline or even turning malicious. Incorporating these layers of aggregation helps introduce redundancy and boosts the overall resilience of the price feed.
This multi-layered approach minimizes the impact of any single source of error or manipulation, ensuring a reliable and tamper-proof price reference point for DeFi applications. Although Chainlink is by far the most
- The Pyth Network primarily acts as a decentralized oracle for Decentralized Finance applications, focusing on high-frequency and ultra-low-latency data. Unlike Chainlink, Pyth sources this information directly from exchanges, trading firms, and financial institutions to make more accurate price feeds. In any case, they are less frequently updated for relevant prices.
- Pyth was built for DeFi and derivative market needs; thus, it has no application cases like Chainlink. However, blockchain oracles, in general, still have a way to be exploited, and some projects, such as Ajna Protocol, consider oracle-free approaches that instead rely on internal orderbooks. While doing so removes Oracle-related risks, this may limit access to exact external market data.