What Are Blockchain Oracles And Why Are They So Important?

Insights
• Jun 13, 2024
What Are Blockchain Oracles And Why Are They So Important?

Blockchain is progressively transforming many sectors and industries, but although it can bring greater transparency, inclusiveness, decentralization, and security, a problem must be addressed. How can the data required for smart contracts be objectively and securely verified? For example, how can blockchain be used in the supply chain while verifying the correctness of the external data inscribed on it? The oracles of the blockchain solve this problem. How do they work?

Blockchain oracles act as intermediaries to verify and authenticate the real-world external data on the blockchain. They act as a bridge between the off-chain data and the blockchain. In this way, smart contracts can interact and be executed based on data from various off-chain sources, verified and approved by the oracles.

At Trakx, we are convinced that blockchain technology is here to stay and will revolutionize numerous industries, from finance to real estate to supply chain and many others. It is precisely for this reason that we believe it is essential to explain how oracles work to enable an understanding of how blockchain can be used with real data.

Blockchain Oracles: How They Work?

Blockchain oracles, acting as intermediaries between the real world and blockchain technology, allow smart contracts to interact with real-world data. This makes it possible to automate numerous processes transparently, securely, and efficiently, giving numerous practical use cases to the blockchain. But how do they work?

  1. Data Retrieval: Oracles utilize various data-fetching techniques, such as API calls, web scraping, and IoT sensors, to access real-time information from external sources.
  2. Data Validation: They employ cryptographic proofs, reputation systems, and consensus algorithms to verify the authenticity and accuracy of external data before injecting it into the blockchain.
  3. Data Transmission: Once validated, oracles securely transmit the external data onto the blockchain, either directly or through predefined protocols, enabling smart contracts to execute conditional actions based on this data.

As you can probably appreciate by incorporating such methods the number of use cases for blockchains is potentially unlimited. In the not-too-distant future, for example, following a car accident, the vehicles involved could 'talk' to each other, and transmit their data to an oracle. After verification and approval this data could be transfered via the blockchain to a smart contract able to automatically execute any insurance reimbursement transaction. Compared with the current insurance claim process the transaction would be both faster (potentially completed in a matter of minutes) and more secure (less open to individual interpretation and possible manipulation).

Now, this is just one example, but it gives an idea of the potential of blockchain oracles combined with smart contracts and IoT. Sounds like science fiction? Well, this is the future we are approaching, and oracles and tokenization will play an increasingly decisive role in ensuring the correctness and objectivity of data. But what types of oracles exist?

Types of Blockchain Oracles

Blockchain oracles come in various forms, each tailored to meet specific needs and requirements within the blockchain ecosystem. Understanding the different types of oracles is crucial for effectively integrating external data into blockchain networks. Now, let's explore the three primary types of blockchain oracles: centralized oracles, decentralized oracles, and hybrid oracles.

Centralized Oracles

Centralized oracles, like IBM Oracle, operate under the control of a single authoritative entity, which acts as the sole source of truth for providing and verifying external data. These oracles are characterized by their simplicity and efficiency in data retrieval and validation. However, their reliance on a centralized entity introduces inherent risks, including the potential for manipulation or data tampering. Since the integrity of the data depends entirely on the trustworthiness of the central authority, centralized oracles may not be suitable for applications requiring high levels of decentralization and trustlessness. Despite their limitations, centralized oracles find utility in scenarios where data accuracy is paramount, and the trustworthiness of the data source can be verified through external means. Examples include fetching exchange rates for cryptocurrency conversions or retrieving real-time weather data for agricultural smart contracts.

Decentralized Oracles

Decentralized oracles, on the other hand, operate via leveraging multiple independent data sources and consensus mechanisms to ensure the reliability and integrity of external data. These oracles adhere to the principles of decentralization and censorship resistance, distributing control across a network of nodes or validators. By aggregating data from diverse sources and validating it through consensus, decentralized oracles mitigate the risks of centralization and single points of failure. Decentralized oracles employ various consensus mechanisms, such as proof-of-stake (PoS), proof-of-authority (PoA), or decentralized autonomous organizations (DAOs), to validate and authenticate external data. Through a process of consensus, these oracles ensure data integrity and consensus among network participants, thereby enhancing trust and reliability in blockchain-based applications. This type of blockchain oracle is well-suited for applications requiring a high degree of decentralization and resistance to censorship or manipulation. Use cases include decentralized finance (DeFi), where oracles provide price feeds for asset valuations and lending protocols, and supply chain management, where oracles verify product authenticity and traceability.

Hybrid Oracles

Hybrid oracles combine elements of both centralized and decentralized models, offering a balance between data accuracy and decentralization. These oracles leverage centralized data sources for efficiency and reliability while incorporating decentralized mechanisms for validation and consensus. By combining the strengths of both approaches, hybrid oracles seek to mitigate the weaknesses inherent in centralized and decentralized oracles. In a hybrid oracle system, data is fetched from centralized sources and then validated and verified through decentralized consensus mechanisms. This hybrid approach ensures data integrity while maintaining efficiency and scalability. However, hybrid oracles may still be susceptible to risks associated with centralization, depending on the degree of reliance on centralized components. Hybrid oracles are suitable for applications where a compromise between efficiency and decentralization is desired. 

Each type of oracle may or may not be suitable depending on the data verification requirements. Thus, before choosing which type of oracle is most suitable for verifying a certain type of data, the needs in terms of decentralization and security must actually be assessed. Indeed, although centralized oracles may be more scalable and faster, they may be much more exposed to data manipulation risks than decentralized oracles. As is also the case with the Blockchain Trilemma, one must try to strike a balance between security and decentralization, and hybrid oracles, for instance, may be the most suitable for a larger number of use cases.

Applications and Use Cases of Blockchain Oracles

As we have explained, blockchain oracles will be increasingly indispensable for efficiently and securely automating smart contracts based on external off-chain data. This opens the door to numerous fields of application, but what exactly?

Decentralized Finance

Decentralized Finance (DeFi) is one of the most important areas of oracle use. It is progressively revolutionizing traditional finance, making it more inclusive, democratic, transparent, and secure. Oracles like Chainlink make it possible to provide reliable and up-to-date price feeds, market data, and asset valuations for executing automated financial transactions. Examples of DeFi applications powered by blockchain oracles include:

  • Decentralized Exchanges (DEXs): Oracles provide price feeds for various cryptocurrency pairs, enabling decentralized exchanges to facilitate trustless and transparent trading without relying on centralized intermediaries.
  • Lending and Borrowing Protocols: Oracles determine collateral valuations and liquidation thresholds, allowing users to borrow funds or earn interest on their crypto holdings without the need for traditional financial intermediaries.
  • Derivatives Trading Platforms: Oracles deliver real-time market data and price indices for creating and settling derivatives contracts, such as futures and options, on decentralized platforms.

Supply Chain Management

Oracles can provide significant advantages in the management of supply chain processes, potentially ensuring traceability, transparency, and efficiency. By integrating real-time data on the origin of products, their movements, and their processing, the end customer can easily verify the product lifecycle in a secure and guaranteed manner. This means that, for example, it will be possible to verify with a simple click all the steps that a product has undergone before ending up on the shelf (tracing, for example, when a fruit was picked, at what time, how, where it was stored, where it was processed, at what temperature, by whom, and so on). In this area, use cases can be:

  • Product Traceability: Oracles provide verifiable data on the origin, production process, and journey of goods from manufacturer to consumer, enabling end-to-end traceability and accountability.
  • Inventory Management: Oracles monitor inventory levels, reorder thresholds, and supply chain disruptions, facilitating timely replenishment and optimization of inventory management processes.
  • Quality Assurance: Oracles collect and validate data from IoT sensors, RFID tags, and other monitoring devices to ensure product quality, compliance with regulatory standards, and adherence to quality control protocols.

Insurance and Risk Management

As mentioned above, an important use case could be in insurance. Blockchain oracles could provide real-time data to insurance companies' smart contracts to automate reimbursement processes and dynamic verifications. By providing verifiable data on predefined triggers, such as weather events, flight delays, or asset valuations, oracles enable parametric insurance models that trigger automatic payouts based on predefined conditions. Some of the examples of insurance applications leveraging blockchain oracles include:

  • Parametric Insurance: Oracles deliver real-time data on weather patterns, natural disasters, and other insurable events, triggering automatic payouts to policyholders based on predefined parameters, such as rainfall levels or seismic activity.
  • Crop Insurance: Oracles provide accurate and timely data on crop yields, weather conditions, and pest infestations, enabling insurers to offer customized insurance products tailored to the specific needs and risks of agricultural producers.
  • Flight Delay Insurance: Oracles fetch flight data from airline APIs or flight tracking services, enabling insurers to offer flight delay insurance policies that automatically compensate travelers for delayed or canceled flights based on predefined criteria.

Although these just-mentioned use cases may already seem revolutionary, the potential of blockchain oracles is much greater. Through them, in combination with smart contracts and IoT, the use cases are almost unlimited. We are only at the beginning of this new technological revolution, and at Trakx, we are convinced that it will lead to a more inclusive, decentralized, secure, transparent, and democratic future. The import and verification of off-chain data via blockchain oracles is the step that is being addressed to make the adoption of blockchain technology widespread in multiple use cases. A more efficient and transparent future awaits us.

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