By Sam Kim, founding partner of Umbrella Network
Something good is growing among us. In the years to come, a layer of intermediaries will be removed who controls our most valuable assets, regulates our access to our own data, and bills us for the privilege in a variety of ways. This group of technologies will transform the way we bank, conduct transactions, borrow, and save. They allow us to interact with one another directly and without trust. Collectively, these applications are known as decentralized finance or DeFi. And if you haven’t heard about it, you will.
When most people think of blockchain technology, they equate it with Bitcoin. A few years ago, with the advent of Ethereum and smart contracts, came the opportunity to program the blockchain to perform actions that are far more complex and potentially far more beneficial than just sending and receiving crypto funds. DeFi projects are visceral examples of this transformation.
DeFi applications essentially fulfill a market-making function. Unlike traditional lenders, exchanges or insurers, they use the blockchain and smart contracts to provide these services transparently and peer-to-peer without the involvement of banks or other central authorities. As a result, they have become very popular, exploding in the last year from a tiny industry to one that is currently valued at over $ 100 billion.
In order for DeFi applications to work and add value to people and organizations around the world, they need information from the non-blockchain world – such as price data for derivatives or weather information for insurance contracts or really almost anything you can imagine. Without access to accurate data, these applications would be of little use. This is what oracles do – they act as connective tissue for accessing, processing, and transmitting critical data. But no oracle system is enough. To ensure the integrity of the data, it must be completely decentralized.
The easiest way to explain oracles is to have them conform to the application programming interfaces (or APIs) that traditional applications use to retrieve data. Suppose Kayak wants to get flight schedules and prices from different airlines. By accessing these airlines’ APIs, this information can be easily accessed and shared with their customers in real time. However, for a blockchain-based project looking for the current price of BTC / USD, the information provided by API endpoints is useless. Oracle solves this problem. You check, ask and authenticate these external sources and then make the data available in the blockchain.
When we learn about oracles, it is very important to realize that they all want to be the bridge that connects important external data from the existing web to blockchain-based applications, but not all of them work the same way. Some oracles are not blockchains themselves and do not benefit from the internal profitability of the blockchain. Those who have different architectures, different ownership structures, and different consensus mechanisms. Decentralization is important when it comes to oracles, because while oracles allow DeFi Smart Contracts to receive outside input and enable endless use cases, they can also present a great structural risk. Centralized format oracles are prone to a single point of failure. If your central authority makes a mistake or is damaged, the entire system is at risk. Many existing oracles describe themselves as decentralized and technically they are, but as with everything, the devil is in the details. As you delve into it, you will find that some oracles are more decentralized than others.
For example, the best known oracle networks retrieve information from various points of sale. Your reviewers will vote on which data points will be added to the feed they send. In that sense they are decentralized. In some of these systems, however, a central authority selects certain data sources and rejects others. It is not trustworthy because users must first trust that the oracle selected the correct data providers and second trust those providers.
Data sources are just one of the places where the details matter. A decentralized oracle must contain a group of independent oracle nodes. However, the mere integration of a group of oracle nodes is not enough to achieve the level of decentralization required to provide high quality data. In order to avoid the vulnerabilities discussed above and to fulfill the fundamental promise of the peer-to-peer technology of blockchain, a truly decentralized oracle network must be a network in which the data sources are selected by the community, validators are selected by the community and the rules for staking are established. including rewards and penalties are set by the community, not a central authority.
The ideal way to ensure that Oracle Nodes operate independently and with integrity is to have the Oracle itself use a Delegated Proof-of-Stake (DPoS) consensus model on its own blockchain. This model allows anyone who owns the network’s native tokens to vote for representatives to rule it. As a result, those who run the network are committed to the community, not private investors or other stakeholders. A DPoS protocol is also structured in such a way that all participants in the network receive an economic incentive to precisely validate the data they have provided.
But if full decentralization is such a straightforward solution, why doesn’t every oracle adopt it? Like many other things, decentralization is easier said than done. Decentralized structures are difficult to implement efficiently, cost-effectively and scalably in order to support fast-moving next-generation applications. To make the solution scalable, the data from all of these nodes must be aggregated, validated, and formatted before being added to the chain to respond to requests in the chain for that particular data point. An innovative solution is to use a system from Merkle Trees to bundle multiple transactions into a single hash. Using this Level 2 solution, each node can validate thousands of transactions for the price normally required to validate a transaction on other networks.
The optimal oracle architecture described here would meet blockchain applications for both security and scalability reasons. It would have a completely decentralized architecture, but would also offer a secure, more cost-effective solution that promotes high volume scalability as well as a wide variety of data. The end result would be a robust, decentralized oracle service that is economical and scalable.
The potential of decentralized applications is limitless and oracles are an essential part of the democratization of our institutions. The key is to implement them in such a way that it does not undermine the most important part of the revolution they promise.
Via Umbrella Network
The Umbrella Network is a scalable and cost-effective decentralized oracle that supports the blockchain and decentralized finance (DeFi) ecosystems. The Layer 2 solution leverages the latest advances in Merkle Tree technology to consolidate multiple data points into a single on-chain transaction to ensure secure, affordable, and accurate data for smart contracts. Learn more at https://umb.network/
The views and opinions expressed are those of the author and do not necessarily reflect those of Nasdaq, Inc.