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Blockchain Oracles, A Gateway for dApps to the real-world

| November 17, 2023

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Smart contracts are driving up blockchain adoption thanks to the various innovative use cases they offer. Programmable cryptocurrency transactions make it possible for endless DeFi applications to be created on-chain, and these applications, known as dApps, exist to satisfy all kinds of purposes — not just limited to managing funds. With blockchain finding practicality in several areas outside of finance, smart contracts are proving highly beneficial in building dApps that are impacting industries outside the sphere of the blockchain ecosystem.

It is common knowledge that blockchain technology is highly versatile and is here to bring disruption in all sorts of industries, but the contradiction arising is that blockchains are also highly siloed infrastructures because of their secure consensus mechanisms. While blockchain consensus is often limited to transaction states that uphold the integrity of the network, external data and factors did not previously possess any infrastructure to influence transactions, not allowing blockchains to be very utilitarian beyond conventional applications. However, with oracles, smart contracts on blockchain networks can now interact with real-world occurrences.

Blockchain Oracles and What They Do

Blockchain technology requires an infrastructure that allows for the transmission of off-chain data into blockchain networks in a robust way. This process is being fulfilled by blockchain oracles, specifically decentralized oracles and their networks. These oracles, which are smart contracts themselves, transmit authentic and verified data to smart contracts in a trustless way. The data received from these oracles act as input for smart contracts, facilitating their execution based on external factors.

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Blockchains are not isolated environments by limitation — their seclusion prevents them from being exposed to human interference and corruption that can severely affect protocol security. This introduces other handicaps, however, to the functioning of smart contracts, which are overcome by oracles. For example, without oracles, sports betting on the blockchain is impossible to execute via smart contracts without placing trust in an off-chain entity. Say bets are being wagered by two parties on a tennis match, the wagers collectively held in a smart contract escrow waiting to be transacted to the party that predicts the right outcome. The only way to communicate the outcome to the smart contract in a trustless way is through an oracle protocol, which will kick off the contract’s functioning, permitting the funds in escrow to be transferred to the cryptocurrency wallet of the party that predicted the outcome.

Obviously, if sports betting is done without the implementation of an oracle, the data sent as input to the smart contract can be rigged resulting in fraudulent transactions — which is why blockchain networks remain isolated from off-chain systems in the first place. Meanwhile, oracles themselves need to adhere to similar consensus mechanisms as blockchain networks to provide authentic information, preventing the loss of funds to bad actors and other undesirable outcomes. Decentralized Oracle Networks are the go-to for most blockchains as they offer robust ways of bringing genuine data on-chain for the appropriate execution of smart contracts and of course, to keep all processes decentralized.

The Different Types Of Blockchain Oracles

While there exist several kinds of oracles, most utilized by blockchain networks fall into at least one of four categories which are determined by factors like decentralization and trust involved — or lack thereof — and the direction in which the data flows — either into the blockchain ecosystem or out of it. Regardless, every oracle needs to query and transmit data that affect desired changes based on smart contract functionality.

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Centralized Oracles

When an oracle is operated by a single entity that communicates off-chain data to blockchains, a certain amount of trust needs to be placed on the oracle and the data it provides, making the protocol centralized. This beats the purpose of blockchain decentralization and the trustless manner of operating it breeds. Centralized oracles can relay tampered data causing fallacious smart contract executions, which in turn can affect incorrect transactions. Blockchain and smart contract security don’t mean much if off-chain sources are allowed to tamper with their functionality. Such is the issue with blockchain oracle integration and is referred to as “the oracle problem”, making centralized oracles highly concerning while in use. This is no different from third parties communicating a false outcome from the tennis match, wrongly resulting in the inappropriate party gaining the wagers from the escrow.

Decentralized Oracles

The factors making the utilization of centralized oracles a massive cause for concern are exactly why decentralized oracles are suggested to be implemented for blockchains to communicate with external entities. Decentralized oracles, before transmitting data to the on-chain smart contract, determine the accuracy and precision of the aggregated data through consensus reached by the network participants of the oracle protocol. The data is only transmitted on-chain after the participants agree to the veracity of the data, eliminating the need for trust and preventing the transfer of suspect data to smart contracts. Decentralized Oracle Networks are gaining major traction with blockchain networks as they aggregate data from rich sources and maintain a considerable amount of decentralization at every level in their protocols.

Inbound Oracles

Inbound oracles supply input data from external systems to blockchain networks and their smart contracts. The data flows inward from extraneous sources enabling the change of smart contract states. For example, inbound oracles are responsible for communicating data like the outcome of the tennis match to the smart contract, which eventually transacts the escrow funds to the party that won the bet.

Outbound Oracles

On the contrary, outbound oracles transmit data outward from the blockchain network to off-chain systems after smart contract execution and often initiate external processes. With IoT use cases becoming increasingly desired by blockchain users, outbound oracles are witnessing rapid adoption. The transfer of crypto tokens from one wallet to another, based on smart contract transactions, initiates the functioning of external. For instance, users can unlock rental motorbikes by transacting the needed funds to the rental service’s cryptocurrency wallet.

Oracles Are Bridging the Gap Between Blockchain Technology And Mainstream Adoption

Blockchain networks are isolated from the real world, but oracle protocols warrant the flow of information and data from legacy systems into the on-chain ecosystem. This is allowing smart contracts to execute a wide range of use cases bringing about massive developments in many areas like DeFi protocols dealing with synthetic assets whose values are derived from off-chain assets, blockchain applications influencing supply chains and identity verifications, and the functioning of AAA games on blockchain networks made possible by the inflow of external computations.

While the seclusion of blockchain protocols was a massive issue hindering its adoption by mainstream industries, oracles are acting as a bridge making these decentralized ledger networks highly interoperable with each other and with other real-world systems.

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