Understanding Oracle Technology in Blockchain

The blockchain is an outstanding technology that registers crypto transactions in a shared ledger, enabling anyone to track operations in decentralised networks and promoting trust in virtual currencies and platforms.

The advancements in blockchain and smart contracts laid the foundation for more use cases that exceed the crypto space, allowing us to benefit from these technologies’ elevated transparency and reliability in real-life applications.

Oracles technology is how we can use blockchain in our daily lives, even for the average user and non-crypto enthusiasts. Let’s discuss what are oracles in blockchain and what makes them unique.

Understanding Oracle Technology

Blockchain technology is a powerful tool that promotes trust and reliability in cryptocurrencies and Web 3.0 operations, acting as the backbone of the decentralised economy. However, its use cases, so far, are limited to the crypto world and decentralised ecosystems.

Most blockchain real-life utilities are theoretical, so how can theory be turned into practice? Oracle is the answer. 

Blockchain oracles allow real-time interaction between the decentralised and centralised economies, enabling exchanges, dApps, DEXes and other crypto tools to provide solutions to real-world events and problems.

Thus, oracles allow the blockchain network to receive and execute data on traditional cloud systems and servers. 

Why We Need Blockchain Oracle Technology?

Oracles in blockchain support the timely interaction between off-chain platforms like bank accounts, trading platforms, or money transfers on the one hand and on-chain networks like decentralised applications, shared ledgers, and exchanges on the other hand.

In a world where illicit entities and scam programs prevail, trust becomes a challenge, especially when transferring a significant amount of money or dealing with sensitive information. 

Therefore, oracles provide a trustless medium where on-chain and off-chain operations are executed automatically once certain criteria are met, much like an Escrow but on a greater scale.

How Do Blockchain Oracles Work?

Blockchain oracles use smart contracts as facilitators for data exchange. Smart contracts offer a significant utility in automation and verification, processing data and initiating actions based on pre-set rules and conditions that lead to an intended course of action.

In a crypto context, smart contracts verify wallet information and requests before fulfilling transactions and registering them in the blockchain. The same utility can be implemented by receiving information from centralised servers and applications and performing certain actions as a result.

Oracles use hybrid smart contracts to initiate requests, specifying the type, amount and source of off-chain data, which is passed to the on-chain oracle contract.

The on-chain oracle node creates a log event to interact with an off-chain oracle node, which creates a task on an external server or application to receive the requested data. The interaction between off-chain nodes and servers works like APIs.

Finally, the data is received on the off-chain nodes that verify and process it into smart-contract-compatible information that performs a pre-determined activity.

Types of Oracles

Crypto oracles are complicated structures of nodes and contracts that power blockchain as a service in different ways. Here are the main types of oracles in blockchain.

Inbound and Outbound

This blockchain oracle type represents the data flow and direction between on-chain and off-chain networks. 

Thus, inbound oracles provide information from the real world to the blockchain structure. For example, buying or selling specific cryptocurrencies if the market reaches a certain price.

On the other hand, outbound oracles deliver data from the blockchain to the outer world. For example, delivering updates and notifications about a certain dApp or crypto game to the user’s device or platform.

Centralised and Decentralised

Centralised and decentralised oracles determine the information source with whom the hybrid smart contracts interact to request and receive data.

Centralised oracles involve only one source to provide external data or on-chain validation. This centralised entity leads all data requests and action implementation.

The downside of centralised oracles is that they are error-prone, meaning that if this single entity gets manipulated or breached, the whole process becomes invalid. This is like relying on a single source for information without further verifying the presented facts.

On the other hand, decentralised oracles entail validating the data through multiple nodes before delivery, leading to more accuracy and efficiency. 

In essence, decentralised oracle networks are similar to shared networks, minimising the risk of a single point of failure and promoting trust by conducting consensus. 

Hardware and Software

This type of oracle in blockchain refers to the nature of the data source. 

Hardware oracles deliver data from physical devices or sensors, such as thermostats, motion sensors, radio frequency receivers, and cameras, to provide information. These tangible sources analyse data in their turn and send it to other applications like off-chain oracle nodes.

On the other hand, software oracles deliver data from digital sources, like servers, websites, exchange rates, travel rates or hotel rates. The information provided by these sources is communicated to off-chain nodes whenever requested, which is further validated and re-formatted to become compatible with the smart contracts. 

Real-World Use Cases of Blockchain Oracles

Blockchain oracles extend the benefits of decentralised ecosystems and explore new ways to apply smart contracts and blockchain features in the real world.

Insurance: Blockchain oracles can use hardware and digital sources to verify car or flight insurance claims. Thus, oracles rely on weather applications or vehicle motion sensors to provide data for an insurance claim.

Real estate: Assets and properties can be tokenised and tied to a smart contract. Once a counterparty provides payment and other required documents, the smart contract verifies the input information and proceeds to transfer ownership.

Trade Automation: Oracles can be used to track specific blockchain activity or a coin’s price action and execute a buy or sell order accordingly. For example, software oracles can track wallet activities of the Ethereum blockchain and notify the user or trade on their behalf based on pre-determined criteria and course of action.

What is The Blockchain Oracle Problem?

The automation and validation features of the oracle technology are vulnerable to manipulation and data inconsistency, which are the main risks of blockchain oracles. 

For example, inbound communication entails tracking market prices and sentiments to produce notifications or execute trading activities. However, malicious actors and bots can manipulate the market by placing massive orders and increasing prices, leading smart contracts to complete inaccurate transactions. 

There are several ways to shift the market to create fake sentiments, such as frontrunning, wash trading and ramping, which intends to artificially increase the demand for a certain asset to drive its price higher.

Conclusion

Blockchain oracles are tools that facilitate interaction between decentralised and centralised platforms, allowing applications and servers of different kinds to communicate and execute certain activities.

This includes asset tokenisation and creating smart contracts that make the purchase process more reliable and efficient without having to trust the counterparty. Decentralised oracle services use multiple nodes to validate requested data, making them more reliable than centralised oracles that have a single point of failure.

Therefore, the extended use cases provided by blockchain oracle technology must be carefully considered because they can be exposed to various manipulations and false information.