How Do Oracles Work In The Crypto World?

Have you ever placed a buy or sell order for a cryptocurrency at a specific price? Or have you ever profited from arbitraging the same coin across multiple exchanges? If you answer yes to one or both of these questions, you have likely benefited from a blockchain oracle.

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@enter.artPUBLISHED 6TH NOVEMBER 2022

What Is A Crypto Oracle? 

A crypto or blockchain oracle is a medium that links the blockchain with the outside world by supplying it with real-life data. It doesn’t produce data but analyzes and authenticates data gotten from reputable sources before passing it on to the blockchain. This way, the blockchain can maintain its core values while being more flexible. 

The need for crypto oracles is highlighted by something known in the crypto world as the oracle problem. Let me break down the concept. Blockchains were traditionally designed to operate outside of external systems. In this way, they can prevent network compromises and downtimes. 

However, if most of the populace is going to adopt cryptocurrencies, smart contracts will have to be developed that will need to connect to real-time events. Thus, there is a need for an intermediary to relay such information to smart contracts in a trusted manner. That is where crypto oracles come in. 

How Does It Work? 

Blockchain oracles function like Application Programming Interfaces (API) as they work alongside the blockchain to supply needed data when due. They either supply data from the outside world to the blockchain or from the blockchain to the outside world. 

Let’s use an example to illustrate this. Let’s say Satoshi and Nakamoto placed a $50 bet each on who would win the UEFA Champions League. To make things fair, they tie up the $100 in an escrow smart contract that will release the funds as soon as the winner is announced. 

This smart contract will have to connect to a sports oracle which will feed it real-time information. As soon as the final match is finished and the winner declared, whoever wins the bet will instantly receive their funds in their wallet with no fuss or hassle. The oracle has completed its mission! 

Where Can They Be Used? 

Oracles have been applied in various aspects of the crypto world. Some of those aspects are:

Crypto Lending And Borrowing 
Lending platforms can use oracles to access financial data in the crypto and fiat segments to determine how close a user is to liquidation and how much they can borrow. An example of a platform that uses oracles is the Aave lending platform. Learn more about crypto lending and borrowing here.

Cross-chain Interoperability 
Sometimes, different blockchains may need to communicate with themselves to process a transaction. By relaying information between blockchains, oracles allow these blockchains to interact seamlessly. You can delve deeper into Blockchain Interoperability in this article. 

Crypto Insurance 
Oracles can supply salient information to crypto insurance platforms about current events. For example, Etherisc uses oracles to provide flight delay and crop protection insurance, among others. 

Dynamic NFTs 
Dynamic NFTs are NFTs that evolve based on external conditions. These NFTs, also known as living NFTs, can be applied in sports, music, art, and even politics. Needless to say, oracles are responsible for feeding these NFTs with the information they need to maintain their dynamism. 

Types Of Crypto Oracles 
The world of crypto oracles is a broad one. Therefore, there are many ways to classify them. However, three significant classifications exist, namely: 

Hardware Or Software 
Hardware oracles use physical items like barcode scanners, thermometers, etc., to get and verify information which they then pass to the blockchain. Software oracles, on the other hand, interpret data from digital sources. They are the most common types of oracles and are used to transmit online data like market price updates, flight information, etc. 

Inbound Or Outbound 
Crypto oracles that bring information from outside the blockchain are called inbound crypto oracles. The scenario of Satoshi and Nakamoto given above is an example of inbound oracles because data from the sports world is brought into the smart contract and used to perform an action. 

There are also outbound oracles that transmit information from the blockchain to the outside world. For example, in the scenario above, an outbound oracle could be used to send an update to the winner of the bet that the money has been deposited in their wallet.

Centralized Or Decentralized 
A centralized oracle is one where a single entity controls the information. While it has its advantages, one piece of wrong information is all it takes to harm the entire system. Also, cryptocurrencies are all about decentralization, and the concept of centralized oracles challenges this. 

On the other hand, decentralized oracles do not rely on just one participant but use various networkers to achieve consensus. As a result, they are also called consensus oracles. Most of them are also more challenging to make than centralized oracles. 

Benefits And Risks Of Oracles 

Benefits 

● Oracles make it easier for cryptocurrencies to be applied in many practical scenarios in day-to-day life. 

● With oracles, many crypto activities can be automated, saving crypto enthusiasts a lot of time and effort. 

● Most oracles are easy to set up compared to many other blockchain tools. 

Risks 

● Since oracles can be applied in some sensitive industries like the flight and medical industries, even the slightest error in information could result in catastrophic casualties.

● Oracles could become compromised like any other crypto project. 

Final Thoughts 

Blockchain oracles are essential tools that have enabled crypto technology to start gaining worldwide acceptance. They allow people to see cryptocurrencies as more than just trade instruments and are easy to create and implement. If you have been in the crypto world long enough, you likely will have used one without knowing it. 

However, oracles are not perfect creations. Therefore, care is to be taken when applying oracle technology. As much as possible, decentralization is to be favored over centralization. That way, even if a network participant is compromised, the entire oracle could still maintain accuracy.



This article is written by Olole Nuel as a part of enter.blog's bounty program. Do you have an interesting topic, series or subject you think would be fitting for enter.blog? 

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