What do weather forecasts and crypto courses have in common? It depends on reliable data sources. Blockchain networks are closed systems. Information on transactions and smart contracts is transparent to all network participants, but no information can penetrate from the outside. This is exactly where oracles come in.
Because oracles are independent computer programs, also called agents, that supply external data to blockchain networks. These can be cryptocurrency rates or even measured values from weather stations. Oracles are integrated into smart contracts through so-called multi-signature contracts. These must be signed by all contractual partners and can represent simple or complex if-then structures.
Five types of Oracle
There are five types of oracles. Oracle Software transmit data that is available online, for example flight cancellations or weather data. Hardware oracles Forward “real world” information, for example, RFID sensor data to monitor supply chains.
Incoming oracles Supply blockchains with external data such as rates in real time while Outgoing oracles Allow data transfer in the opposite direction: smart contracts send information abroad. in Consensus basisOracles are multiple oracles connected to each other to create a consensus of independent data providers.
Essential for smart contracts
Oracles have a special function for smart contracts. Initially, smart contracts are 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 will also be activated 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 preset date. But what if the activation of a smart contract is linked to several conditions?
The more complex, the more error prone
The more real-world information needed to revive a smart contract, the more smart contracts are prone to errors. 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 transmitted, it can cause considerable financial damage to both the insurance company and the insured person.
It is not a panacea
So when 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. Tampering or incorrect data cannot verify oracles either. Thus, the oracles unearth a problem that blockchain technology really wanted to solve: reliance on trust. If you access external data, you must also trust the data provider. So do oracles hollow out the “no trust” command in the crypto space?
Not necessarily. Oracle vendors are working on various solutions to get around the problem. Consensus-based oracles are one approach to minimize the likelihood of incorrect data. Another comes from the Oracle Chainlink network.
Chainlink: the oracle of DeFi
Chainlink is a network of nodes that feeds “off-chain data” into smart contracts via oracles and therefore represents an important support for many applications in the field of decentralized finance (DeFi). The Chainlink ecosystem currently has over 700 integrations and partnerships, the best known of which are the DeFi Aave and Synthetix protocols.
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 reliability. Nodes increase their reputation by transmitting correct data, so untrusted oracles are displaced. Chainlink’s order matching contract relays the request to the relevant nodes. Chainlink’s aggregation contract finally compares the results of the oracles against each other. The data is fed back to the Chainlink protocol through 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 must deposit LINK as a deposit. If they misbehave, they put their invested capital at risk, and in turn, a high and honest stake is rewarded with LINK tokens.
Although Chainlink ensures natural selection with the reputation system, it cannot completely avoid the trust problem. The human default break point always remains, even if it minimizes susceptibility to tampering. However, 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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