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Why Oracles are critical to DeFi’s development

8 minutes a month ago

Oracles are critical for many aspects of the blockchain industry, especially for decentralised finance (DeFi) applications. DeFi protocols rely on oracle networks for real-time on-chain data and event-based outcomes to support the operation of decentralised applications (dApps) such as insurance products, algorithmic stablecoins, financial derivatives, and prediction markets.

Why Does Blockchain Require Oracles?

The combination of blockchains (immutable on-chain code) and oracles (secure off-chain data), also known as hybrid smart contracts, creates a powerful synergy between them that lays the groundwork for advanced blockchain applications. Oracles allow previously closed networks to consume trustworthy external data and give them the ability to interact with legacy systems. Smart contracts can respond to real-world events and integrate with established business processes using an Oracle.

Along with obtaining external data (usually up-to-date price feeds) and delivering it on-chain, Oracles also operate as a filtering system for such information, which is crucial when external inputs can trigger the automation of a high-value transaction.

What Oracles can offer

Many people associate oracles with price feeds which are frequently utilised in defi transactions, most notably loan issuance, derivatives, and stablecoins.

Protocols like Maker rely on a price feed to determine the value of the underlying collateral that backs the asset. In this way, oracles can act as their own auditors, constantly monitoring for fraudulent activities. A wide range of stablecoins use Chainlinks Proof of Reserve oracle networks to safeguard users against fractional reserve practices and black swan events.

"Without the external financial market data that oracles provides, you can’t really build defi," co-founder of Chainlink, Sergey Nazarov explains, "Most of defi is built using the ‘hybrid smart contract’ model, which combines on-chain code and off-chain systems using oracle networks."

Popular Oracles

Chainlink

Chainlink has a central agency that makes sure that nodes report to different price feeds. The agency is similar to a centralised oracle, where it influences the liveness guarantee and the extent to which data can be manipulated or censored.

Chainlink focuses on high-quality data and provides access to paid APIs. They can even act as middleware, completing specific tasks that require authentication, because they have central parties. If you are interested you can buy Chainlink here.

The Band Protocol

Band provides "community-curated" data sources that enable dApp operators to contribute to the management and curation of data feeds, hence resolving the oracle problem and providing smart contracts with credible data feeds. Band is distinguished from Chainlink in this aspect, as it enables decentralised applications to access data via smart contract data points rather than external oracles. You can view more information about BAND on CoinSpot here.

Decentralised Information Asset (DIA)

DIA is an open-source oracle platform that enables market participants to source, provide, and share trustworthy data. It is essentially a platform that enables access to crowd-verified financial data, hence facilitating the establishment of a fair and symmetrical financial ecosystem. Its mission is to deliver clear, secure, and verifiable market data. You can find DIA on CoinSpot here.

Tellor

Tellor is a decentralised oracle that provides Ethereum price data. It works by having a network of staked miners compete to solve a PoW challenge and submit the solution, as well as the requested data. Tellor uses game theory and crypto-economic incentives to keep the system secure. The economic incentives are also set up to make sure the Ethereum network is live even when it is under stress, you can find Tellor here.

Back To The Future

Although speculation has been the most common defi use case thus far, the introduction of gamified finance, blockchain-based insurance, prediction markets, governance, supply chain management, and digital identity, all point to an exciting future. Having a reliable data feed is critical for long-term success. Providers of data services who ignore Oracles do so at the cost of their Web3 existence.

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