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November 27, 2023

What is a Blockchain Oracle and How Does It Work?

Blockchain oracles are data sources that feed external information into smart contracts, enabling them to interact. Know more about what is blockchain...

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Shardeum Content Team

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You may not hear about them often, but blockchain oracles are the unsung heroes connecting the digital universe of blockchains with the real world. They’re like giving blockchains a pair of eyes and ears, allowing them to interact with the world outside. Oracle allows blockchain technology to be not just a static ledger but a dynamic system impacting and reacting to the real world.

So, what is a blockchain oracle? And how do blockchain oracles weave their magic? Here we go.

Table of Contents

What is a Blockchain Oracle?

Given the decentralized and trustless nature of blockchains, there’s a fundamental challenge: how can a decentralized system, designed to function immutably and without relying on trust, accept information from external, and/or centralized sources? Blockchains cannot, by design, access external information on its own.

While the closed nature of blockchains ensures security and trustworthiness, many applications, especially smart contracts, require data from the outside world to be truly useful. Smart contracts, for instance, self-execute actions based on predefined rules or triggers. However, smart contracts are not inherently aware of real-world data, such as weather conditions. They need an external source to provide this data for them to make decisions or execute functions. This is where oracles come in. Oracles are third-party services that fetch and supply data from external sources to the blockchain. They act as the “bridge” between on-chain (blockchain) and off-chain (external) systems.

An Example of Blockchain Oracle

Let’s take the weather example. Imagine a decentralized insurance platform that compensates users if their flight is canceled due to bad weather. The smart contract governing this insurance would need real-time weather data to determine whether a claim is valid or not. However, the smart contract doesn’t inherently know the current weather conditions. This is where the oracle comes in. The oracle fetches the weather data from a trusted weather reporting website or service and inputs it into the smart contract. With the data provided by the oracle, the smart contract can verify if conditions warrant compensation for a weather-caused cancellation and then decide to release the funds if necessary.

How Does Blockchain Oracle Work?

The functioning of a blockchain oracle involves the seamless integration of external, real-world data with on-chain smart contracts. Here’s a step-by-step explanation of how blockchain oracles work:

Data Collection: Oracles actively seek out information from various off-chain sources. These sources can include websites, APIs, IoT devices, sensors, or even human input. The goal is to collect relevant and real-time data that could impact or influence the execution of smart contracts within a blockchain network
Data Validation: Once the oracles gather external data, they meticulously validate its authenticity. This step is crucial to ensure the accuracy and reliability of the information being brought onto the blockchain. Validation helps prevent the inclusion of false or manipulated data, maintaining the integrity of the smart contracts.
Transmission to Smart Contracts: Validated data is then transmitted to the on-chain smart contracts. This data serves as the input or trigger for predefined conditions within the smart contract. Smart contracts, now armed with real-world insights, can autonomously execute actions or decisions based on the received external data.
Autonomous Execution: Smart contracts, having received the validated data, can execute predefined conditions or actions without the need for manual intervention. This autonomy is a key feature, as it allows smart contracts to respond to dynamic external events in real time.
Symbiotic Relationship: The relationship between blockchain oracles and smart contracts in a blockchain platform is symbiotic. Oracles provide the necessary real-world information, transforming smart contracts from static, on-chain entities into dynamic, adaptable components of decentralized applications giving real world value and utilities.

Types of Blockchain Oracles

Blockchain oracles come in various types, each serving specific purposes and catering to different needs within the decentralized ecosystem. Here are the main types of blockchain oracles:

Software oracles: These are coded entities that systematically access and verify external data. Software oracles use their programming capabilities to fetch information from predefined sources such as online APIs, databases, exchanges and other digital platforms.
Hardware oracles: Hardware oracles involve physical devices equipped with sensors that act as conduits for real-world data. They connect blockchain networks with Internet of Things (IoT) devices and other hardware, enabling the integration of tangible elements into decentralized applications.
Inbound and outbound oracles: Inbound oracles bring external information into the blockchain, acting as conduits for data from the real world to smart contracts. Outbound oracles transmit blockchain data to external systems, facilitating bidirectional connectivity between on-chain and off-chain environments.
Centralized and decentralized oracles: Centralized oracles rely on a single source for data, which can be a potential point of failure. Decentralized oracles (or DONs) aggregate data from multiple independent sources, enhancing reliability and security through a distributed approach.
Contract-Specific oracles: These oracles are tailored to the specific needs of individual smart contracts. Contract-specific oracles provide data exclusively tailored to the conditions and requirements specified within particular smart contracts, enhancing precision and relevance.
Human oracles: Human oracles involve real people in the validation and provision of information for smart contracts. Despite the human touch, stringent mechanisms are put in place for data accuracy, and prevent manipulation by adding a layer of trust to the decentralized, trustless ecosystem. Human oracles typically refer to the manual entry of data.

Challenges of Blockchain Oracles

Blockchain oracles play a crucial role in connecting decentralized applications with real-world data, but they face several challenges inherent to their function. Here are some key challenges associated with blockchain oracles:

Reliability of external data: Oracles gather information from diverse off-chain sources, and ensuring the accuracy and reliability of this external data is a significant challenge.
Risk of Data Manipulation: There is a potential risk of malicious actors manipulating the data provided by oracles considering most of them are centralized at this point in 2023.
Security Vulnerabilities: Oracle networks become attractive targets for cyberattacks due to the critical role they play in facilitating the exchange of information and value between the blockchain and the real world.
Decentralization vs. Data Accuracy Balance: Striking a balance between decentralization and maintaining high data accuracy is challenging. Centralized oracles might introduce a single point of failure, while decentralized oracles need to ensure consensus among diverse data sources.
Integration Complexity: Integrating blockchain oracle solutions in decentralized applications (or dapps) can be complex. Developers need to carefully design and implement the integration to avoid potential issues and vulnerabilities.
Scalability: As blockchain technology evolves and the demand for decentralized applications grows, ensuring the scalability of blockchain oracles adds up to the perennial necessity for them to scale. Handling a large volume of data transactions in real-time requires a high throughput architecture while maintaining high decentralization and security.
Cost and Resource Intensity: Some oracle solutions can be resource-intensive, both in terms of computation and storage. The cost associated with deploying and maintaining oracles may present challenges for certain blockchain platforms although the prevalent method adopted is by making use of third party oracle providers who can charge a subscription fee from their users in return for their services
Regulatory Compliance: Oracles need to interact with real-world entities and therefore complying with regulations is vital. This adds a layer of complexity to their operation.

Blockchain Oracle Use Cases

Now let’s explore a couple of blockchain oracle use cases in DeFi and the supply chain industry.

DeFi (Decentralized Finance)

One of the blockchain oracle use cases is decentralized finance (DeFi). The integration of blockchain oracles into the area of decentralized finance (DeFi) is nothing short of revolutionary. DeFi applications leverage oracles to provide smart contracts with real-time access to critical financial data, such as price feeds and market information. This integration empowers smart contracts to execute complex financial transactions autonomously, creating a decentralized financial ecosystem that operates seamlessly and transparently.

Supply Chain

In supply chain management, blockchain oracles emerge as indispensable facilitators. They play a pivotal role in tracking and verifying the journey of products by integrating real-world data into blockchain systems. This includes monitoring product location, temperature, and quality, thereby enhancing transparency and accountability throughout the supply chain. The result is a streamlined and tamper-resistant system that ensures the integrity of products from creation to delivery.

Future of Blockchain Oracles

The future of blockchain oracles unfold with promising potential. As technological advancements address existing challenges, blockchain oracles are poised to become even more integral to decentralized applications.

Innovations in data validation, consensus mechanisms, and security protocols will likely enhance the reliability and trustworthiness of oracles. This evolution positions oracles to play a pivotal role across various industries, expanding the horizons of decentralized applications and solidifying their status as a transformative force in the broader blockchain landscape.

Conclusion

In the grand tapestry of blockchain technology, oracles stand as vital threads, seamlessly pulling off on-chain and off-chain connectivity. The types of blockchain oracles, ranging from software to DONs to human oracles, address specific use cases, rendering decentralized applications adaptable and yet robust. As the bridge between the digital and tangible worlds, blockchain oracles usher in a future where decentralized applications become even more versatile, responsive, and integral to multiple industries.

Frequently Asked Questions (FAQs)

1. What can Oracles do?

Oracles, acting as intermediaries between the blockchain and the real world, empower smart contracts, within a blockchain network, to access real-world data. This functionality expands the capabilities of smart contracts beyond on-chain data processing, and allows them to respond dynamically to external events. In essence, oracles enable smart contracts to be not just automated scripts but adaptable components, enhancing the utility and relevance of decentralized applications (smart contracts serve as the backend logic for dapps).

2. What are Oracles in Solidity?

Solidity, the programming language for Ethereum Virtual Machine (EVM) smart contracts, benefits from oracles by connecting its data to the external world. This enriches the capabilities of smart contracts, allowing them to make informed decisions based on real-time, off-chain information, thereby enhancing their functionality and relevance in diverse industries.