What is an oracle in blockchain? The importance of accurate data feeds

Often overlooked, blockchain oracles are essential to a functioning blockchain network

Abstract image of digital person, vectors and nodes on 2D face profile – Photo: Shutterstock                                 
Knowledge is power for the blockchain – Photo: Shutterstock


What is an oracle in blockchain?

In the words of Ryan Sean Adams, founder of Bankless, “without oracles, blockchains are like computers without an internet connection”. But what is a blockchain oracle and why are they so important?

Oracles are an undervalued part of the crypto ecosystem. They serve as the conduit between the blockchain and the “real” world, relaying data points from numerous sources and feeding them into smart contracts, which then rely on this information to perform essential functions.

While this information could be basically anything – weather, betting odds, football scores, the price of a Big Mac – blockchain oracles are typically concerned with pricing data of fiat and digital assets.

In a topical example, the Terra blockchain’s oracle module feeds LUNA exchange rates into TerraUSD in order to facilitate accurate arbitrage trading. At least it did, until the Terra blockchain officially went offline after LUNA’s collapse.

While savvy developers can code their own blockchain oracles, oracle service providers are commonplace. The most popular is Chainlink, whose clients include the decentralised finance (DeFi) protocols Aave and Compound, the derivatives protocol Synthetix, and the Paxos asset-backed stablecoin.

Screenshot of Chainlink’s oracle data flow – Source: chain.link
Chainlink’s oracle data flow – Source: chain.link

Accurate blockchain oracles are more important than ever in the world of DeFi and synthetic assets, where accurate pricing data is critical to executing trades, swaps and arbitrage. As burgeoning concepts such as on-chain insurance and real estate deeds gain traction, oracles could become an increasingly scrutinised element of the blockchain ecosystem.

The oracle problem

In Ethereum’s words: “Ethereum transactions cannot access off-chain data directly. At the same time, relying on a single source of truth to provide data is insecure and invalidates the decentralisation of a smart contract. This is known as the oracle problem.”

A blockchain dependent on a single source of external data is not just unreliable, but also leaves the network prone to malicious actors. Thus the ongoing debate is how to properly implement decentralised oracles. Julien Thevenard, an associate at the crypto investment firm Fabric Ventures and an expert in blockchain oracles, explained that using multiple data sources “to decrease the likeliness of false data reporting” is vital; the more the better.

Just as blockchain validators earn block rewards by relaying transactional information accurately, having skin in the game can also incentivise accurate data reporting by oracles. The Terra blockchain adhered to this principle before collapsing.

Ticker troubles: The importance of decentralised oracles

Chainlink’s data flow showing multiple points of market data – blog.synthetix.io
Chainlink’s market data is gathered from multiple sources – Source: blog.synthetix.io

What if a singular source of price data is used in the above situation? On 26 April, a little-known token called Ionomy with the ION ticker rose in value by getting on for 11,000,000%  according to Coin Market Cap. Not bad for a dead coin with trading volumes in the single digits.

Except, of course, this information was wrong. CMC confused Ionomy (ION) with another project called Osmosis, whose individual token value was many thousands of times high than Ionomy. CMC was not totally to blame; Osmosis uses the same ION ticker.

Screenshot showing CoinMarketCap’s incorrect ION trading price – Source: coinmarketcap.com
That’s quite the moonshot – Source: coinmarketcap.com

Blame aside, the hiccup showed how reliance on a singular pricing oracle could have been a disaster for the informational supply chain. An error of that scale by a market data supplier could wreak havoc on Ethereum’s smart contracts. Thankfully, the glitch affected the price of an obscure, barely used token, while the use of multiple oracles would have probably captured the misleading data anyway.

In brief

So in basic terms, what is an oracle in blockchain? They are used to connect real-world data feeds with the blockchain, allowing smart contracts to perform functions based on pricing data or any other necessary information.

Blockchain oracles garner little attention. But with the exponential growth of DeFi, on-chain insurance and other financial products, the necessity for properly decentralised, accurate data feeds is becoming increasingly important.


Why are oracles important in blockchain?

Oracles feed essential real-world data into blockchain smart contracts, which then use this data to execute functions. While this data could be anything, from football scores to the price of fuel, oracles are mainly used to gather pricing data.

How do blockchain oracles work?

Oracles work as a coding function in a smart contract. While project developers can write oracle codes themselves, Chainlink and similar businesses provide oracles as a service.

What are blockchain oracles used for?

Blockchain oracles are predominantly used to collate real-world pricing data. However, oracles can provide data feeds on almost anything, from sports and voting results to the current temperature in Florida.

Further reading

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