What is a blockchain oracle?

Blockchain technology has gained significant popularity in recent years due to its potential to revolutionize virtually every industry in some way. However, in order for blockchains to function efficiently, they require trusted and reliable data sources. This is where blockchain oracles come in.

In this article, we'll explain what blockchain oracles are, explore the different types of blockchain oracles, and introduce the technology's benefits and challenges.

TL;DR

• A blockchain oracle provides a bridge between a blockchain and an external data source, allowing the smart contracts on that same blockchain to interact with real-world data.

• The oracle verifies the data before it's added to the blockchain, making sure it's accurate and untampered with.

• Both centralized and decentralized oracles exist. A centralized oracle is a single entity that gathers data from multiple sources and provides it to the blockchain. A decentralized oracle is a network of nodes that work together to provide data to the blockchain.

• Traders interact with a blockchain oracle when they access a platform that shows changing price data on cryptoassets. The oracle helps to pull this price data onto the platform.

• Oracles bring many benefits, including enhancing the functionality of smart contracts and improving the accuracy and reliability of data. However, the technology's common challenges include security risks, complexity, and high costs.

What is a blockchain oracle?

The role of blockchain oracle. Image source: 3commas.io

A blockchain oracle acts as a bridge between a blockchain and external data sources. It provides a way for smart contracts, which are self-executing contracts, to interact with real-world data.

Oracles are essential for blockchains to operate efficiently in real-world scenarios. The oracle acts as a trusted data source and verifies information before it's added to the blockchain. The role of the oracle is critical because it's meant to ensure the data added to the blockchain is accurate and tamper-proof, making it an essential component of the blockchain ecosystem.

How does a blockchain oracle work?

Blockchain oracles act as a bridge between the blockchain and external data sources, providing a way for smart contracts on the blockchain to interact with real-world data. The process of providing data to a blockchain through an oracle typically involves three steps:

1. Data request: When a smart contract on the blockchain requires data from an external source, it sends a request to the oracle.

2. Data verification: The oracle then verifies the data by using trusted data sources such as APIs, web crawlers, or other offchain data sources. The data is checked for accuracy and integrity, and if the data is deemed valid, it's then sent back to the smart contract.

3. Data transmission: The data is then transmitted to the blockchain, where it's added as a transaction. This transaction is then verified and validated by the blockchain's nodes, to maintain the accuracy and immutability of the data.

Types of blockchain oracles

There are two main types of blockchain oracles: centralized and decentralized.

Centralized oracles

A centralized oracle is a single entity that provides data to the blockchain. It is often a trusted third party that collects and verifies data from external sources before providing it to the blockchain. Centralized oracles are typically faster and more reliable than decentralized oracles but are also more vulnerable to attacks and manipulation.

Decentralized oracles

A decentralized oracle is a network of nodes that work together to provide data to the blockchain. It relies on a consensus mechanism to verify the accuracy and integrity of the data. As a result, decentralized oracles are more secure and resistant to manipulation but can be slower and less reliable than centralized oracles.

In addition to these two categories, there are also a few sub-types of oracles, including:

• Hardware oracles: These oracles use physical devices such as sensors or RFID chips to provide data to the blockchain.

• Software oracles: These oracles use software programs to collect data from external sources and provide it to the blockchain.

• Prediction oracles: These oracles provide data on future events, such as the outcome of a sports game or stock prices.

• Reputation oracles: These oracles use reputation systems to determine the trustworthiness of data sources and provide data based on that reputation.

The type of oracle used depends on the specific use case and the level of trust and security required.

Meanwhile, oracles can also be categorized as inbound and outbound, which refers to the direction data travels between a blockchain and the external source. An inbound oracle brings data into a blockchain, while an outbound oracle moves data from a blockchain to an external source. Inbound oracles are most commonly used today.

Blockchain oracles trust challenges

While blockchain oracles play a critical role in enabling blockchains to interact with the real world, some trust challenges are associated with their use. These issues include:

1. Centralization: Centralized oracles are vulnerable to attacks and manipulation as they rely on a single trusted entity to provide data to the blockchain. If this entity is compromised, it can introduce inaccurate or malicious data into the blockchain.

2. Data verification: The accuracy and integrity of the data provided by the oracle depends on the quality of the data sources used and the verification process employed by the oracle. If these sources or processes are unreliable or compromised, it can lead to inaccurate or fraudulent data being added to the blockchain.

3. Interoperability: Different blockchains may require different types of data from different sources, making it challenging to standardize the data provided by oracles. This can lead to interoperability issues and limit the usefulness of the data provided by oracles.

Many consider decentralized oracles as the answer to mitigating the challenges above because they don't rely on a single centralized entity to verify the accuracy and integrity of the data provided.

Blockchain oracles in DeFi

Decentralized finance (DeFi) has seen remarkable growth in recent years, reaching a total value locked of $82.2 billion as of mid-2024. Oracle tokens have gained particular popularity in the DeFi community thanks to their utility and the asset's historical performance.

Blockchain oracles have played an instrumental role in DeFi development, as they enhance data reliability and accuracy across various DeFi protocols. Various DeFi protocols have launched price oracles to offer transparent pricing data to users. For instance, money market protocol Compound announced its decentralized price oracle, the Open Price Feed (OPF), in August 2020. In the OPF, price reporters — such as cryptocurrency exchanges, DeFi protocols, and OTC trading desks — can submit margin trading and lending price data using a known public key. Users can fetch the reported pricing data by accessing the public application programming interface of price reporters. The price oracle is decentralized, as the submission of and access to price data can be conducted without using the infrastructure of the Compound protocol.

The growing popularity of decentralized oracle platforms — notably Chainlink — also fueled the recent growth of DeFi. Chainlink offers decentralized oracles that retrieve and deliver financial data for derivatives and lending. For instance, Chainlink claimed its oracles have retrieved data for over 90% of the volume of derivative lending defaults among public blockchains. This data is adopted by DeFi derivatives providers such as Synthetix, Nexus Mutual, and MCDEX.

By relying on decentralized oracle platforms, DeFi protocols can save time and resources while fostering innovation in other areas of decentralized finance.

Examples of blockchain oracles

There are several examples of blockchain oracles being used in real-world applications:

1. Chainlink: Chainlink is a decentralized oracle network that provides secure and reliable data to smart contracts on various blockchains. It uses a network of nodes to verify the accuracy and integrity of data received from various sources, including APIs and data feeds.

2. Band Protocol: Band Protocol is a decentralized oracle network that provides cross-chain data for various blockchains. It uses a combination of delegated Proof of Stake and Proof of Authority consensus mechanisms to verify the accuracy and integrity of the data.

3. Augur: Augur is a decentralized prediction market platform that uses an oracle to provide data on the outcome of events. Users can place bets on the outcome of events such as sports games, elections, and financial markets, and the oracle provides the outcome data to settle the bets.

4. Oraclize: Oraclize is a centralized oracle service that provides data to various blockchains, including Ethereum, Bitcoin, and EOS. It uses trusted data sources such as APIs and web crawlers to provide data to smart contract platforms.

5. Harbinger: Harbinger is a decentralized oracle service that provides price data for various digital assets, including cryptocurrencies and stablecoins. It uses a network of nodes to verify the accuracy and integrity of the data and provides data to smart contracts on various blockchains.

Benefits of blockchain oracles

Blockchain oracles offer several benefits to the blockchain ecosystem.

Increased functionality for smart contracts

By providing real-world data, blockchain oracles support the functioning of more complex and sophisticated smart contracts that can interact with external data and automate processes based on that data.

Improved accuracy and reliability of data

By verifying data from trusted sources, blockchain oracles aim to ensure that the data added to the blockchain is accurate and tamper-proof, increasing the reliability of the data and reducing the risk of errors or fraud.

Greater interoperability between blockchains

Blockchain oracles can provide cross-chain data to enable interoperability between blockchains, allowing for the seamless exchange of data and assets between blockchain ecosystems.

New use cases for blockchain technology

Blockchain oracles open up new possibilities for blockchain technology, such as prediction markets, supply chain management, and Internet of Things applications, where real-world data is essential for the blockchain to function effectively.

How might blockchain oracles be used in the real world?

The ability of blockchains and smart contracts to access offchain data from various sources presents a great variety of real-world opportunities.

For example, oracles could be used to optimize logistics by allowing systems to be updated in real-time with complete traceability. Should a shipment face disruption such as bad weather or spoilage, the smart contracts controlling the system can be updated to reflect the new circumstances. All modifications can be traced for total transparency among all involved parties, while the smart contracts will continue to execute autonomously based on the new conditions.

Challenges with blockchain oracles

While blockchain oracles offer several benefits to the blockchain ecosystem, there are also several challenges associated with their use.

Security risks associated with centralized oracles

Centralized oracles are vulnerable to attacks and manipulation, as they rely on a single trusted entity to provide data to the blockchain. If this entity is compromised, it can introduce inaccurate or malicious data into the blockchain.

For example, there's the man-in-the-middle attack. Here, a malicious actor gains access to the data flow between the oracle and the smart contract. The actor then modifies or falsifies the data, which lowers the data quality provided by blockchain oracles.

Difficulty in verifying data from decentralized oracles

While decentralized oracles can reduce the risk of attacks and manipulation, verifying the accuracy and integrity of the data can be challenging. The consensus mechanism decentralized oracles use must be robust and secure to prevent malicious nodes from introducing fraudulent data.

Regulatory issues with using third-party data sources

Using third-party data sources can introduce regulatory risks, as these sources may not comply with legal requirements and may introduce inaccurate or fraudulent data into the blockchain.

Complexity and cost

Implementing a blockchain oracle can be complex and expensive, requiring significant resources and expertise. Additionally, the cost of using oracles can be high, as data providers may charge fees for providing data to the blockchain.

Blockchain developers and users can employ various strategies to address these challenges. For example, developing new technologies and protocols can help reduce the complexity and cost of implementing blockchain oracles, making them more accessible to a wider range of users.

The final word

Blockchain oracles are essential in enabling blockchains to interact with the real world, allowing smart contracts to access real-world data and execute based on that data. They offer several benefits to the blockchain ecosystem, including increased functionality for smart contracts, improved accuracy and reliability of data, greater interoperability between different blockchains, and new use cases for blockchain technology.

However, there are several challenges associated with their use. These include security risks associated with centralized oracles, difficulty verifying data from decentralized oracles, regulatory issues with using third-party data sources, and complexity and cost. As blockchain technology matures, we expect to see more innovative uses of blockchain oracles. This development could also bring about the creation of new technologies and protocols to address the challenges encountered today.