Home » Blockchain » What is a blockchain oracle and how does it work?

A blockchain oracle is a third-party service or software that provides off-chain data to a blockchain smart contract. The decentralized web3 ecosystem requires access to existing legacy systems, advanced computations, and data sources. Decentralized oracle networks facilitate the creation of hybrid smart contracts. Hybrid smart contracts combine code running on the blockchain (on-chain data) and off-chain infrastructure to create complex decentralized applications. The  Hybrid smart contracts get executed based on real-world events and interoperability of traditional systems.

Blockchains are self-contained and secure but have limited access to external data sources. Oracles bridge the blockchain and the outside world by verifying and transmitting data to the blockchain.

How does blockchain Oracle work?

How does blockchain oracle work

The role of a blockchain oracle is to collect and verify external data, and then send it to a smart contract on the blockchain. The oracle can gather data from various sources, such as web APIs, sensors, IoT devices, and other off-chain data sources. Blockchain Oracle will verify its accuracy and integrity through various means once the data gets collected. Cryptographic signatures and consensus mechanisms are some of the ways to ensure the accuracy and integrity of data.

Once Oracle has verified the data, it will then send it to the smart contract on the blockchain. The smart contract can then use this data to execute various actions or trigger events on the blockchain, such as updating the state of a decentralized application, triggering a payment, or settling a dispute.

Blockchains rely on oracles to enable smart contracts to interact with the outside world securely and reliably. However, oracles also introduce new potential vulnerabilities to the system, such as the risk of data manipulation or fraud. As such, it is important to carefully design and implement oracles to ensure the security and reliability of the blockchain system.

Blockchain oracles are divided into the following categories based on the characteristics governing source, information direction, and trust:

Software Oracles

They communicate with online information sources (databases, servers, and websites) and transmit that information to blockchain smart contracts in real-time. Prices for digital assets, exchange rates, current flight information, etc, are all included in the information.

Hardware Oracles

These oracles gather data from computers, barcode readers, and other information-gathering tools. Hardware oracles deliver real-world events to smart contracts for decision-making in a form that can be understood digitally.

Inbound and Outbound Oracles

The direction of information to be transmitted determine inbound and outbound oracles. Receiving off-chain information and transmitting it to blockchain constitute inbound Oracles. Getting cryptocurrency and assets’ price information from exchanges is a typical example of Inbound oracles.

While outbound oracles transmit information from blockchain to outside sources, a smart contract is an excellent example of an outbound oracle. In case the money gets deposited to a specific address, the smart contract communicates this information to a mechanism. This mechanism then opens the smart lock through an outbound oracle.

Consensus-based Oracles

These oracles utilize multiple oracles and consensus algorithms to derive accurate data for smart contacts, ensuring that data transferred to a blockchain is accurate. This oracle scraps data from multiple sources to transfer specific and correct data.

Compute-enabled Oracle

Due to various reasons, such as block constraints, smart contracts applications utilize secure off-chain computing to render decentralized services that are otherwise impossible to do on-chain. Compute-enabled oracles can perform complex computations such as running algorithms, executing smart contracts, and providing output to the blockchain.

Human Oracles

Humans can provide data feeds and insights to a smart contract or decentralized apps (dApp) on the blockchain. The opinions can be based on real-time events or observations. The individuals can provide inputs that are otherwise difficult to obtain through traditional data sources. Inputting weather predictions in smart contracts is one of a kind.

Contract-specific Oracles

This oracle has a one-time use case. They are designed to provide relevant and specific data to smart contracts’ needs.

Blockchain Oracle use cases

Blockchain oracles can be used across various industries and provide valuable data feeds to smart contracts and dApps. Blockchain oracle use cases are not limited to particular industries. Below are some examples where Blockchain Oracle can be used:

DeFi: DeFi ecosystem requires oracles for financial data access to markets and assets. The information can be used to trigger buy/sell orders. Blockchain oracles generate accurate price feeds on DEXs like Uniswap.

Supply chain management: Real-time tracking of goods is possible through blockchain oracles. Blockchain oracles can also provide valuable information such as the temperature and environmental condition of goods, ensuring that products are stored and transported under proper conditions.

Gaming: Blockchain oracles provide thrilling and unpredictable outcomes for online games and events. They also ensure engaging gameplay by allowing users to make bets or promote random matchmaking. Compute oracles can also be used to generate verifiable randomness for creating dynamic NFTs that can change the appearance of random loot boxes.

Insurance: Verifying the occurrence of events such as natural disasters or flight delays can reduce false claims. Blockchain oracles can be used to automate claim processes, reduce the risk of fraud and provide faster payouts to policyholders.

Rewards to loyal customers: Blockchain oracles can track customer activity and reward loyal customers with crypto or NFTs stored in smart contracts.

Voting: Transparency in voting is what most activists are looking for. Blockchain oracles can pave the way to direct democracy. Blockchain-based oracles can record and transfer voting data to smart contracts in a tamper-proof way.

Sustainability: Blockchain oracles can provide greater transparency by tracking and monitoring emissions and providing better incentives for green practices. By applying advanced ML computations on smart contracts, rewards can be dispensed to people who reforest or follow eco-friendly practices to reduce carbon emissions.

What is the blockchain Oracle problem?

In a world where blockchain and smart contracts are prominent, the Oracle problem has also been under the spotlight. Blockchains are unable to pull and push data to external sources or systems. Blockchain oracles resolve this problem of connectivity. But blockchain oracles do face problems. The inability to confirm the reliability and accuracy of data from the blockchain oracle is the biggest barrier to the success of the blockchain ecosystem. Blockchain oracles can be compromised. This means malfunctioning and deliberate tampering with smart contracts, which could result in financial losses. Since oracles do not come under blockchain consensus, their reliability and trust always remain a concern. In light of the inability of blockchain oracles to provide trust, the trustless execution of smart contracts remains a question.

Another issue that crops up with the blockchain oracle is its incompetence to maintain privacy and confidentiality. Some data sources may contain sensitive or confidential information that should not be exposed to the public blockchain network

What is the solution to the Oracle problem?

Blockchain oracles should guarantee the reliability and security that the blockchain offers. A decentralized oracle can come as a savior and resolve trust and reliability issues. It utilizes a decentralized network of nodes to eliminate single points of failure in smart contracts. Decentralized oracles such as Chainlink utilize multiple data sources to minimize counterparty risk. Many platforms are heading towards decentralized Oracle development to avoid data manipulation and falsification.

And when it comes to maintaining sensitive or confidential information, the use of secure communication protocols can address this.

Wrapping up

Oracles have a significant role in revolutionizing the blockchain industry and shaping the future of DeFi applications. They can provide real-world data to be successfully used on the blockchain. Similar to the case when the internet brought changes to the way information is stored, blockchain oracles will enable hybrid smart contracts to have connectivity with real-world data and enforce contractual agreements.

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