These programs allow to introduce external data to the block chains.
Although they are essential, there are important questions about their safety.
“Oracle” is a term oft repeated in the decentralized finance (DeFi) ecosystem. However, many users do not know what it is, what its function is or which are the most used on the main platforms.
To understand the function of oracles, it is necessary to begin by reviewing what smart contracts are and their objectives. These contracts allow the automation of various operations that take place in decentralized networks. Ethereum is the prime networking example for this use case.
Smart contracts allow different types of operations to be carried out without the need for an intermediary person to authorize, reject or regulate them. For example, when trading bitcoin (BTC) futures contracts or any other crypto asset, a smart contract allows for settlement to take place on the agreed date and for each counterparty to receive what is due.
The same applies to generating interest from strategies such as yield farming or ‘yield farming’. The tokens that are given as a reward are distributed through a function already specified in the code of the smart contract. Likewise, stablecoins or stable cryptocurrencies need the listing of their underlying assets in order to maintain parity with them.
What are oracles?
To execute this type of operation, smart contracts need to obtain certain information that varies permanently and, therefore, must be updated.
It is at this moment that the oracles play their role, are programs that they work like bridges between networks and the real world. These can be queried to feed information into smart contracts, including data as varied as price reports or weather forecasts.
Which are the most used and what distinguishes each one?
Oracles provide their services to various DeFi protocols. These platforms depend heavily on the proper functioning of the oracles, since they use them to consult market prices and calculate the interests that apply to the services they provide.
Some oracles are more widely used than others. Quantitatively, this can be measured from the total value locked (TVL) added by the DeFi platforms that use them, data that can be found on sites such as defillama.com along with other statistics that are set out in the following list. Next, we propose a review of three of the most used oracles and their main characteristics.
Chainlink is an oracle that can be used on various networks, such as Ethereum, BNB Chain (former Binance Smart Chain), Terra, Solana or Polygon, among others. This protocol has USD 53.9 billion in TVL and there are 161 DeFi protocols that use it. Anchor is its main client, with a dominance of 30% with respect to the other protocols, among which Aave, Compound, 1inch and Loopring stand out.
According to their official Web site, Chainlink is based on multiple APIs (software for integrating services and applications) that are unified into a validated result. This “eliminates any single point of failure,” according to the developer company of the same name. Some of the sources consulted by this oracle are CoinMetrics, CoinGecko, Binance, Kraken, Amberdata, dxFeed, among others.
To offer your oracular services, Chainlink uses a network of independent, geographically distributed nodes and “highly reputable.” The information they provide, is detailed, can be verified in real time through third-party software interfaces.
Apart from offering the price of certain assets in real time, Chainlink also provides information on financial markets, network status, weather data, and news from various fields in real time.
Maker’s Oracle tracks and reflects the prices of various assets, both real world and cryptocurrencies, which function as collateral in the Vaults. These are deposits that support the issuance of the DAI stablecoin by the MakerDAO protocol.
In addition, it also allows the protocol to determine the values of the collaterals that are deposited on the platform to obtain loans or of the crypto assets that are blocked there to generate interest.
This oracle has the peculiarity that It provides its services to only two protocols: MakerDAO —the majority, with 99% dominance— and Keep Network. However, with just these two, it accumulates a TVL of USD 13,750 million.
As explained in the white paper either White book From MakerDAO, the Maker pricing oracle is based on “a broad set of individual nodes” chosen by the governance of the protocol. This means that those who own the Maker (MKR) token can participate in the choice of these trusted sources for monitoring market prices.
To ensure the reliability of information, Maker uses a system called the Oracle Security Model (OSM), which delays sending data by one hour. In that time, an oracle can freeze if it is suspected of being hacked or corrupted.
TWAP, from English Time Weighted Average Price (“time-weighted average price”) is a oracle developed by Uniswap, the decentralized exchange (DEX) of Uniswap Labs. The function of this oracle is to provide the price of various cryptoactives to DeFi platforms such as Compound, Prism Protocol and Mars Protocol, according to what the defillama.com site details.
As its name indicates, and also as explained by the documentation available on the Uniswap site, TWAP is a methodology that calculates the average price of an asset over a specific period of time.
This mechanism gives them greater resistance to attacks that seek to manipulate the displayed prices, since the prices are taken at the beginning of the mining of a new block and considering the price of the last transaction of the previous block. This technical detail complicates any hacker attack attempt, according to specialists explain.
This oracle presents several differences that puts it at a disadvantage compared to others. For example, the Chainlink one mentioned above works on a volume-weighted average price (VWAP). This method takes benchmarks such as price support and resistance to gauge market trends, and provides greater accuracy at times of high volatility.
In addition, another point against it is that the Uniswap oracle is more limited in terms of the sources it uses to display prices, since it is based primarily on the indicators of this DEX, whose price is governed by the supply and demand of the assets. Even this oracle leaves out other assets in the real financial world, such as commodities and stocks on the stock market.
Benefits and risks of oracles
Taking all of the above into consideration, the importance of oracles for the proper functioning of DeFi platforms is evident. They are like a gear in an engine that cannot be missing, even though it is not visible.
However, they are not exempt from certain questions about their safety. As CriptoNoticias has reported, oracles are not entirely safe because they depend on third parties, who are its developers and the data sources they consult. Consequently, they are exposed to hacks, corruption and state regulations, all elements that confront the essence of decentralized finance. This is precisely to function without intermediaries.
The Ethereum Foundation, an entity that brings together the developers of that network, express that “an oracle is only as secure as the data sources it uses.” And he adds that “it is possible for an attacker to alter the price (…) to manipulate the understanding of the current price that a dApp (decentralized application) has.”
How can this problem be counteracted? The use of different feeds or data sources is a key point, details the FE. Likewise, as was written in this newspaper, decentralization —both technological, due to the number of nodes, and geographical, due to its location— is also vital to reduce the interference of control bodies.
In short, there is still a lot to be developed for these instruments to be totally reliable, as several specialists assure in the aforementioned CriptoNoticias article. However, several of them also agree that some of the ones that currently exist, referring to Chainlink and MakerDAO, are effective for using DeFi platforms. Similarly, it is not recommended to deposit all savings in these protocols, since they do not offer the same security that a cryptocurrency wallet can offer.