What Is a Blockchain Oracle?

Consider a scenario where Kevin and Samuel place a bet on the outcome of a football match, each wagering $200 on their respective teams. The funds are held in escrow by a smart contract, ensuring automatic payout to the winning party.

However, the smart contract, being a set of code, can only act based on predetermined on-chain conditions. How does it access off-chain data to determine the match results?

This is where a blockchain oracle comes into play. The Oracle is a mechanism that collects accurate off-chain data, delivering it reliably to the blockchain, allowing the smart contract to execute actions accordingly.

In the blockchain world, a connection with the real world is essential. Whether for decentralized insurance using meteorological data, supply chain tracking with geolocation data, or determining Ethereum prices for decentralized finance (DeFi), accessing external data is crucial for smart contract applications.

So, how do we bridge the gap between these two worlds? This is through blockchain oracles — they are entities that connect blockchains to external systems. This article will go into the details of what these entities are, how they function, their types, and the diverse areas in which they can be applied.

Understanding a Blockchain Oracle?

Blockchain oracles serve as third-party services that provide external data to smart contracts, acting as a vital link between the real world and blockchains.

In situations where off-chain data, not residing within the network, is crucial for executing the terms of smart contracts, blockchain oracles become indispensable. These oracles establish a connection between off-chain and on-chain data, significantly expanding the applications of smart contracts within the blockchain ecosystem.

Without blockchain oracles, smart contracts would face severe limitations, confined to accessing data solely within their networks. The role of a blockchain oracle involves analyzing, authenticating, and verifying external data sources before relaying the information to the smart contract. Oracles convey diverse information forms, ranging from price details and payment completion success to match results, election outcomes, insurance-related incidents like fires, or sensor-measured temperature data.

The process involves implementing the smart contract first and then utilizing network resources to fetch data from the external world. Certain oracles can also transmit data back to external sources in addition to relaying it to smart contracts.

How Does It Work?

A blockchain oracle connects a blockchain to the outside world. Smart contracts use oracles to obtain external data, enabling them to execute predefined actions based on that data.

In a financial contract, for instance, an oracle may provide real-time pricing data. The smart contract then automatically carries out actions, like buying or selling an asset when its price hits a specific point.

Oracles retrieve data from external sources, aggregate it, and format it for the smart contract's understanding. This process, known as "data aggregation," transforms the data into actionable 'events' for the smart contract.

Different Kinds of Blockchain Oracles

Oracles are a type of infrastructure, similar to application programming interfaces (APIs), but with distinct differences.

Hardware Oracles: Extract data from the real world using devices like barcode scanners and sensors. For example, a sensor detecting a truck at a loading bay can transmit data to a smart contract.

Software Oracles: Exchange data with internet sources and send it to the blockchain. Common for real-time information like exchange rates or digital asset prices.

Inbound Oracles: Deliver information to smart contracts from external sources. An example is providing a smart contract with temperature readings from a sensor.

Outbound Oracles: Transmit information from smart contracts to the external world. For instance, a smart lock unlocking in response to money deposited to an address.

Centralized Oracles: Single-source managed by an organization, posing risks due to reliance on one entity. Vulnerable to a single point of failure.

Decentralized Oracles: Eliminate counterparty risk by querying multiple oracles for data accuracy. Also known as consensus oracles, improving resistance to attacks.

Contract-specific Oracles: Tailored for a specific smart contract, offering flexibility but may be costly to maintain for numerous contracts.

Human Oracles: People with expertise in a sector who gather, validate, and convert information into smart contracts. Cryptography ensures authenticity.

Cross-chain Oracles: Facilitate data transfer between multiple blockchains, enhancing interoperability.

Compute-enabled Oracles: Use secure off-chain computation for decentralized services not feasible on-chain due to technical, financial, or regulatory constraints, commonly employed in Layer 2 solutions like ZK Rollups.

Applications of Blockchain Oracles

Decentralized Finance (DeFi): Blockchain oracles are integral to DeFi systems, facilitating transactions for services like home purchases, health insurance, and retirement plans. They serve as a link between smart contracts and real-world data, determining collateral levels and borrowing capabilities in financial transactions. Platforms like AAVE utilize price feed oracles for smart contract implementation. ReHold is as an example of a decentralized finance (DeFi) earning platform that leverages the blockchain oracle Chainlink to determine the prices of tokens, including Ether and Tether, listed on its platform

Decentralized Applications (dApps): Oracles enhance interactions with blockchain for users lacking technical expertise. Applied in social media activities and financial prediction markets, they empower users with control over their data, expanding capabilities beyond initial intentions.

Non-Fungible Tokens (NFTs): Oracles play a crucial role in creating a verified randomness function (VRF) for maintaining the uniqueness of NFTs with random assignments. They address challenges in connecting NFTs to off-chain activities, enabling quicker creation of NFTs linked to real-world objects and memories.

Stablecoins, CBDCs, and Banking: Oracles are essential in monitoring collateralization and updating pricing for stablecoins, tokens linked to fiat money or commodities. They also play a crucial role in tracking and validating off-chain reserves for stablecoins. In the context of Central Bank Digital Currencies (CBDCs), oracles contribute to ensuring stability and accurate pricing.

Advantages of Using Blockchain Oracles

Flexible Parameters: Oracles offer adaptable parameters, enabling actions to be executed once or repeatedly. They provide two options: operating within the blockchain or passively reporting.

Access to External Data: Oracles allow blockchains with access to external data necessary for complex operations. This access makes it possible for blockchains to communicate with external sources, broadening their application to activities such as investing, trading, and purchasing.

Automation of Smart Contracts: Oracles removes the need for manual entry of blockchain transactions. When configured correctly, an oracle can execute smart contracts in response to external triggers. While it isn’t suitable for complex scenarios, oracles handle straightforward tasks without constant supervision, saving time and effort.

Risks Associated with Blockchain Oracles

Interference from Third-Party Players: Interacting with blockchain oracles involves external processes and intermediaries linking users to the blockchain, potentially leading to centralization issues. Interference from third parties can pose challenges to the integrity of the blockchain system.

Inaccurate Data: Malevolent behavior or honest errors in the data received by an oracle can result in poor judgments. Ensuring the use of secure and trustworthy data is crucial for the safety and reliability of blockchain systems.

Conclusion

The widespread adoption of blockchains hinges on a reliable system enabling seamless communication between smart contracts and the external world. Blockchain oracles play an important role in overcoming limitations, allowing smart contracts to access data beyond their networks. The deployment of blockchain oracles is crucial for the trustworthy, dependable, and safe expansion of the blockchain ecosystem.