The role of oracles in DeFi is very crucial because they enhance DeFi applications by providing off-chain data to on-chain smart contracts.
Smart contracts operate within the blockchain’s closed ecosystem and cannot access data from the outside world, such as market prices, weather conditions, sports scores, etc. This is where oracles come in.
In this article, we explore the roles of oracles in enhancing DeFi applications.
What are DeFi Applications?
Dapps, short for Decentralized Applications, are software applications built on decentralized networks, primarily using blockchain technology.
They operate on a peer-to-peer (P2P) basis, eliminating the need for centralized authorities or intermediaries.
Dapps prioritizes decentralization, security, transparency, and user privacy. They can be found across various sectors, including finance, social media, gaming, and more.
Dapps transforms traditional centralized systems by offering a more transparent, secure, and user-controlled experience. They represent a significant step towards a decentralized internet, where users have more autonomy and control over their digital lives.
What is an Oracle?
An oracle, or blockchain oracle, is a third-party service for smart contracts. Oracles provide trusted information based on outside-world sources to on-blockchain smart contracts.
Oracles are foundational in creating the verifiable web, connecting blockchains that would otherwise be isolated to off-chain data and computing, and enabling interoperability between blockchains.
Blockchain Oracles bridge the blockchain and the external world, providing intelligent contracts with real-time and verifiable data.
They serve as trusted sources of information, fetching data from various off-chain sources such as APIs, websites, and IoT devices and delivering it to smart contracts.
This enables smart contracts to interact with real-world events and make informed decisions based on up-to-date information
Simply put, a blockchain oracle connects blockchains to external systems, enabling smart contracts to execute based on inputs and outputs from the real world.
In DeFi, oracles are essential for various applications. For example, in decentralized exchanges (DEXs), Oracles provide price feeds for different assets, allowing traders to execute trades based on accurate market prices.
Similarly, in lending and borrowing protocols, Oracles provides data on interest rates, collateral values, and credit scores, enabling the calculation of borrowing limits and interest payments.
Types of Oracles in DeFi
Given the extensive range of off-chain resources, blockchain oracles come in many shapes and sizes.
Not only do hybrid smart contracts need various types of external data and computation, but they also require various mechanisms for delivery and different levels of security.
Generally, each type of crypto oracle involves fetching, validating, computing upon, and delivering data to a destination. Here are the types of oracles:
- Input Oracles
- Output Oracles
- Cross-chain oracles
- Compute-enabled Oracles
Input Oracles
Today’s most widely recognized type of oracle is called an “input oracle,” which fetches data from the real world (off-chain) and delivers it onto a blockchain network for smart contract consumption.
These oracles power Chainlink Price Feeds, providing DeFi smart contracts with on-chain access to financial market data.
Output Oracles
The opposite of input oracles is “output oracles,” which allow smart contracts to send commands to off-chain systems that trigger them to execute certain actions.
This can include informing a banking network to make a payment, telling a storage provider to store the supplied data, or pinging an IoT system to unlock a car door once the on-chain rental payment is made.
Cross-Chain Oracles
Another type of oracle is a cross-chain oracle that can read and write information between blockchains.
Cross-chain oracles enable interoperability when moving both data and assets between blockchains. This includes using data on one blockchain to trigger an action on another.
Compute-Enabled Oracles
Compute-enabled oracles are a new type of oracle that is becoming more widely used by smart contract applications.
This Oracle uses secure off-chain computation to provide decentralized services that are impractical to do on-chain due to technical, legal, or financial constraints.
This can include using Chainlink Automation to trigger the running of smart contracts when predefined events occur.
Popular Examples of Oracles
Oracles allow the decentralized Web3 ecosystem to access existing data sources, legacy systems, and advanced computations
Some examples of Oracle solutions are:
- Chainlink
- Band Protocol
- SupraOracles.
Chainlink
Chainlink is a decentralized oracle network that enables smart contracts to access off-chain data sources and external applications securely. Connecting blockchain technology to the real world is crucial to providing reliable, tamper-proof data feeds and APIs.
Chainlink employs a network of nodes, known as oracles, that gather and validate data from various sources. These oracles then transmit the verified data to the blockchain, which can be used to trigger smart contract executions. This process ensures that smart contracts can interact with the outside world securely and transparently.
Band Protocol
Band Protocol (BAND) is a decentralized data oracle platform that provides high-quality data to smart contracts on various blockchains, such as Ethereum and Cosmos.
It aims to connect real-world data with blockchain networks securely and transparently.
SupraOracles
SupraOracles is a multi-chain oracle platform providing secure, reliable, high-performance data solutions for decentralized applications (dApps) across various blockchain networks.
It aims to offer a comprehensive suite of data services, including data sourcing, aggregation, and validation, to ensure the seamless integration of real-world data with smart contracts.
The Role of Oracles In DeFi Applications
Oracles act as a bridge between the blockchain ecosystem and the real world. They provide essential data and services that enable smart contracts to interact with external sources effectively. Some key roles of oracles in DeFi apps include:
- Real-world data integration
- GameFi and NFT integration
- Prediction markets
- Enhancing smart contract functionality
- Off-chain computation
- Cross-chain interoperability
- Identity verification
Real-world data integration
DeFi applications often require information from external sources, such as stock prices, weather data, or sports event outcomes.
Oracles facilitate the integration of this real-world data into the blockchain environment, allowing smart contracts to make informed decisions based on accurate and up-to-date information.
GameFi and NFT integration
Oracles can assist in connecting DeFi applications with the rapidly growing GameFi (Gaming + DeFi) and NFT (Non-Fungible Tokens) sectors.
By providing real-world data related to in-game events or NFT market trends, oracles can enhance the interactivity and value of DeFi applications within these emerging industries.
Prediction markets
Oracles can power prediction markets in DeFi applications, where users can bet on real-world events’ outcomes.
By providing reliable data on the event’s actual outcome, oracles ensure that payouts are distributed accurately and fairly to the winning participants.
Enhancing smart contract functionality
Oracles can also extend the capabilities of smart contracts by enabling them to interact with external systems and APIs.
This allows for integrating various services and functionalities into DeFi applications, expanding their potential use cases and utility.
Off-chain computation
Oracles can perform complex computations off-chain and relay the results to smart contracts on the blockchain.
This can alleviate the computational burden on the blockchain network and improve the overall efficiency of DeFi applications.
Cross-chain interoperability
Oracles can facilitate communication and data sharing between blockchain networks, enabling seamless interoperability between various DeFi applications built on different platforms.
This promotes the growth and adoption of DeFi by allowing users to access a broader range of services and opportunities.
Identity verification
In some DeFi applications, oracles can help verify identities by securely connecting users’ real-world identities with their blockchain wallets.
This can enhance the security and compliance of DeFi platforms while streamlining users’ onboarding processes.
Conclusion
Oracles are the critical enablers of DeFi, bridging the gap between blockchain and real-world data.
They provide smart contracts with the necessary information to perform complex functions and transactions that depend on external data.
Oracles enhances the security, reliability, and scalability of DeFi protocols by ensuring that the data they provide is accurate, timely, and verifiable and that the data sources are decentralized, diversified, and incentivized.
