The Functions of Oracles in Decentralized Finance

Oracles are essential to the operation of decentralized exchanges today. They perform several functions and help in the execution of smart contracts created on these decentralized platforms.

New investors in the crypto space may wonder, What are Oracles? and What are the functions of Oracles? To get answers to these questions, we urge you to read this article on the roles of oracles in Defi.

What Are Oracles?

For many newbies in the crypto space, the term oracle may mean a seer or prophet with abilities to see the future. However, in the crypto space, oracles perform the function of messengers by providing real-world data to the blockchains.

The data provided by oracles aid in the creation and execution of smart contracts created on these blockchains. In conventional situations, this role is assigned to a trusted third party. However, with the creation of blockchain technology and the elimination of intermediaries, a system must be created to provide real-world data to develop and execute smart contracts.

The operation of smart contracts on centralized crypto platforms is relatively easy. This is possible because the oracle is designed to source data from a trusted source. For example, a smart contract on a centralized platform may require data regarding the coin price of BTC/USDT to execute the terms of its contract.

In this situation, the oracle may be designed to source data from a trusted centralized exchange like Binance or Coinbase. The oracle instantly gets the coin price for BTC and relays it to the smart contract. Furthermore, parties to the smart contract are provided with API to verify the actual value of the BTC coin price at the point of execution of the smart contract.

However, this system may not be practical for Decentralized crypto platforms because Defi platforms like Ethereum are created to prevent interference by a third party. The Ethereum platform is particularly designed as a self-contained platform that prevents external data from third parties.

This self-contained feature creates problems for decentralized platforms, commonly referred to as the “oracle problem.” However, a suitable solution has been found for the oracle problem, and this solution is called the decentralized oracle.

Decentralized Oracle

This unique oracle system uses an open network of providers to reach a consensus. The principle that guides the decentralized oracle system is similar to regulations that apply to blockchains. Usually, blockchains split trust among different blockchain members, thereby creating a system of checks and rechecks.

The use of this open network of providers creates an inflow of real-world data from many sources. Therefore, the oracle has multiple sources of data at its disposal to provide real-world data. This system removes control of the oracle from one central source and provides a measure of security and fairness in the execution of smart contracts.

When compared to centralized oracles, decentralized oracles are slow and expensive. However, this serves as an advantage as it makes it difficult to manipulate data on this system. Furthermore, this oracle system offers a higher degree of liveness guarantee. The benefit of these is that data can be verified from multiple sources before using or executing smart contracts.

Some of the most decentralized oracles developed on the Ethereum platform include:

· Compound

· Maker

· Tellor

Compound

The compound oracle system is similar in structure to the Maker oracle system. However, this oracle has a network of reporters and uses a different design for handling what happens after real-time data get on-chain. Additionally, the data feeds via this oracle system will not appear instantly.

The reporters that supply information in this oracle system are usually reliable exchanges and major parties in the crypto space who have a solid price system and provide their price values through a public medium. This system offers the incorporation of data from several centralized exchanges into Defi.

Maker

The oracle structure developed for MakerDao mirrors a proof-of-authority model that offers privacy. Currently, this structure allows any user to act as a relayer for the system. However, there is still a bit of anonymity for the network providers and their rewards.

On Maker, oracle updates are usually delayed by 1 hour. This feature allows token holders on the maker platform to determine if oracle updates are suitable or not. Similarly, the platform is designed to allow users to freeze the system in case of bad updates. A benefit of this feature is that it will enable users to make decisions instead of solely relying on updates provided by the oracle structure.

Currently, this centralized oracle supports many systems built on the Ethereum platform. This includes the Dydx and many other similar projects that require a secure feed for the ETH/USD coin price.

Tellor

This decentralized oracle provides smart contracts with price data on Ethereum. Tellor accomplishes its objective by using a network of staked miners to solve a proof of work and provide the solution while also providing the requested data. However, staked miners must compete to solve the POW challenge to receive any rewards.

This oracle structure uses game theory and crypto-economic incentives to preserve security on its network. In terms of speed, the tellor oracle updates its feed every ten minutes. One benefit of this oracle is that it is difficult to manipulate. Also, the incentives are constant even in times when there is pressure on the Ethereum network.

Conclusion

The importance of oracles in the execution of smart contracts for Defi can not be overstated. However, currently, the number of fully decentralized oracles available limited. Furthermore, most decentralized oracles are not fully decentralized and require continuous data feeds from centralized platforms. However, this may change in the future with more innovation and creativity in the Defi space.