Author: FRANCESCO. Compiler: Cointime.com QDD
What is an oracle?
Simply put, an oracle is an infrastructure that acts as an intermediary between the blockchain and any off-chain data (APIs, cloud service providers, payment systems, IoT devices, etc.).
To achieve this functionality, oracles contain on-chain and off-chain components.
l On-chain: Connect to the blockchain to monitor requests, broadcast data, sign transactions, and perform calculations.
l Off-chain: Process requests, retrieve external data, send blockchain data to off-chain systems and perform off-chain calculations.
Why do we need oracles?
Unfortunately, blockchain cannot solve the oracle problem.
While blockchain provides trustless verification of on-chain data, verifying off-chain data introduces trust assumptions.
l Once I receive the $1000 bank transfer from Bob, I will send him $1000.
l What is the price of Tesla (TSLA)?
l What is the temperature in London today?
Which is the correct answer? How do we cryptographically prove that something is actually true?
Different data sources may produce different results, leading to subjectivity and potential manipulation, and causing irreversible actions on the blockchain by smart contracts that rely on data provided by (malicious) data sources.
These challenges could undermine the essence and value proposition of blockchain.
Off-chain data is critical to supporting core smart contract functionality: imagine if there were thousands of different data sources, most of which were centralized, and we had no idea if we could trust them or if they were malicious and trying to manipulate smart contract outcomes.
This is also why all those “supply chain tracking” initiatives are largely useless - if the off-chain data is plugged in by a surveillance system, then tracking the supply chain is essentially pointless. The origin of the data cannot be verified, and if the information is wrong then the entire system doesn’t function properly in the first place.
Solving the oracle problem on-chain brings scalability, cost, and security issues. Embedding oracles directly on-chain may bring governance challenges and overload the network because oracles need to process a large amount of data, which will affect transaction costs and lead to unsustainable transaction fees.
Most importantly, in terms of security, introducing oracles on-chain is not feasible as it would add complexity to the base layer of the blockchain network, jeopardize its stability, and increase the possible surface for attack possibilities.
In order to maintain a clear focus on consensus and finality, the oracle operates separately from the blockchain.
This ensures that the blockchain has a smaller attack surface and maintains its determinism by focusing on consensus, while oracles generate certainty in the complex and subjective off-chain world without creating dependencies and limitations that pose risks to other applications.
However, relying on oracles to provide off-chain data introduces security issues if the oracles are not trustless.
Centralized oracles actually weaken the trustless nature of blockchain networks because users must trust these oracles to provide accurate and reliable data.
The whole purpose of smart contracts is to enforce the terms of the contract through technological means rather than probabilistic execution through manual execution.
And no one wants to deal with a single point of failure, or have to trust anyone.
In addition to the “classical” oracle problems, the development of a multi-chain ecosystem, including multiple third layers on top of the second layer, has also expanded the role of oracles and introduced additional risks.
Regardless, the demand for oracle services will only increase.
Models that rely on centralized oracles are inconsistent with the core value proposition and core principles of blockchain networks.
To overcome these shortcomings, oracles need to create the same security and reliability guarantees as blockchains.
How to move forward?
In this section of the article, we use Chainlink as a case study, focusing on how they decided to overcome the centralized oracle problem, and CCIP as a solution to the multi-chain oracle problem.
Connect the whole world
Chainlink’s total locked value (TVS) exceeds $130 billion according to DefiLama, excluding CeFi. Chainlink’s TVS alone accounts for half of the total locked value of DeFi protocols, while protecting more than 300 DeFi protocols.
TVS is a unified metric that helps summarize the overall economic impact and adoption of oracle networks. The “Protection” portion of “Total Value Locked” specifically refers to the protection of oracle solutions against data manipulation and delivery corruption, thereby preventing the loss of user funds.
If CeFi is taken into account, Chainlink’s TVS would be close to $750 billion.
How did Chainlink become the leading oracle solution?
Chainlink is leading the way in the quest for decentralized oracles to achieve finality at the oracle level.
Probabilistic and deterministic outcomes
While probabilistic outcomes are sound in theory, they can be problematic in the face of fraud and deception: you can define the protocol and the outcomes perfectly, but the guarantee system on paper can fail (fraud, deception, etc.).
Therefore, to obtain a high-quality and reliable protocol, you need to have both:
The certain truth
l Contract system that guarantees a defined truth outcome
Chainlink envisions a world where cryptographic truth underpins all reliable protocols and will become the gold standard for our future financial systems.
To achieve finality at the oracle level, Chainlink developed the Distributed Oracle Network (DONs).
Currently, there are more than 1,007 DONs.
Chainlink does not rely on a single oracle, but rather on over a thousand DONs for specific use cases.
So why can we trust Chainlink’s data?
Chainlink’s solution to the blockchain oracle problem is to build DONs by adopting several principles to achieve finality.
Chainlink’s DONs are distributed and open source. This setup allows anyone to independently verify the reliability and security of the oracle network.
The distributed nature of DONs also ensures that no single node or data source becomes a single point of failure. Instead, all data is verified by multiple nodes, guaranteeing timely and tamper-resistant data delivery.
This ensures data availability, timely delivery, and resistance to manipulation. Users can always confirm the integrity of the network through cryptographic proofs provided by DONs, signed by nodes and stored on the chain.
In addition, DONs are also blockchain and hardware agnostic. This flexibility enables DONs to grow across multiple chains and perform more advanced computations using advanced software and hardware such as zk-proofs.
Chainlink strives to lower the threshold for DONs services, for example, by introducing the Off-Chain Reporting Protocol to cut costs by 10 times, thereby driving the rapid growth of DONs.
While initially focused on data provision, Chainlink’s product suite now also includes:
Here are some possible use cases:
l Data provided: on-chain and off-chain asset pricing
l VRF: Random number generation for on-chain games and prediction markets
l Proof of Reserves for Centralized Exchanges, Wrapped Tokens, and Stablecoins
l Off-chain data sources for smart contract automation
l Simple blockchain integration for enterprises
The image below provides a breakdown of Chainlink’s customers across key business areas (although it may be outdated).
Chainlink’s core business remains data provision, but we can already see its popularity growing in other areas.
The more blockchains there are, the more problems there will be
In a multi-chain world, there will be more and more problems.
As the number of blockchain networks increases, the need for powerful cross-chain solutions also increases.
One use case is improving the security and reliability of bridges.
Unfortunately, bridge hacks have become a major security concern in DeFi.
According to Chainalysis, 69% of stolen crypto funds in 2022 came from these hacks.
In some cases, hackers have targeted bridges by manipulating oracles used by the protocol, such as token prices, and gaining access to multi-signatures that can propagate (malicious) messages between different networks (e.g. Ronin, Harmony). This is what Chainlink is addressing with CCIP so that this is no longer an attack vector.
Additionally, proof reserves can already be used by bridges to prove their collateral between networks.
Prior to the introduction of DONs, centralized price feeds were constantly under attack. Currently, bridges face the same issues - we are waiting for Chainlink to announce CCIP as the next industry standard.
Chainalysis estimates that in 2022, DeFi protocols lost more than $400 million in 41 separate oracle manipulation attacks.
These issues will unfortunately only get more complex: DeFi, dynamic NFTs, on-chain gaming, and on-chain insurance, to name a few, will continue to grow.
Therefore, the ever-increasing multi-chain and multi-layered blockchain infrastructure requires the development of global standards that set a blueprint for secure and trustless cross-chain interactions. While Chainlink does solve the communication problem between the on-chain and off-chain worlds, the emergence of the so-called "Internet of Contracts" requires secure trustless communication between different blockchain networks and making liquidity globally accessible - not just limited to independent single chains.
In the words of Chainlink CEO, “Connecting them will mean raising the level of the entire industry,” with the ultimate goal of creating a more secure new financial system.
Linking the multi-chain universe
Enter the Chainlink Cross-Chain Interoperability Protocol (CCIP).
The importance of CCIP to Chainlink is self-evident.
The team has been working on CCIP for over 3 years, which is the equivalent of 5 centuries in the cryptocurrency timeline.
You might be wondering why it took so long?
Chainlink isn’t just trying to connect and bridge all of these networks.
More importantly, they do so while also seeking to have deterministic guarantees on the immutability and validity of the data.
What is Chainlink CCIP?
Chainlink CCIP is the abbreviation of Chainlink Cross-Chain Interoperability Protocol.
At its core, CCIP is an interoperability protocol whose purpose is to:
l Promote cross-chain real-world assets
l Expanding the cross-chain ecosystem
l Bridging private and public chains
l Enable token transfer between different blockchains
l Assist in creating cross-chain applications
The CCIP itself is a single and simple interface through which dApps and Web3 entrepreneurs can securely meet all cross-chain needs.
This is not just a fancy word for moving tokens around, but a protocol focused on communication and messaging.
Of course, CCIP will also create many different bridges to enable the transfer of tokens between different chains and dApps. However, this is only a limited part of its overall scope, which is to bring the industry into the world of cross-chain smart contracts.
Through CCIP, you will be able to launch a single smart contract consisting of multiple on-chain contracts and multiple off-chain services, providing a bridge in the form of communication and the ability to obtain data and perform trust-minimized off-chain computations.
You’ll be able to leverage the security guarantees of some chains, the speed or scalability guarantees of others, and use many more as showcases.
Imagine how developers could easily deploy tokens or mint NFTs on dozens of networks, and how users could have a better wallet user experience that abstracted away the different networks.
The scale of this update will greatly benefit the crypto space: imagine the countless hours of development time saved by no longer having to build custom multi-chain solutions for developers.
In fact, the introduction of CCIP could drastically reduce development time, bringing it closer to Web2: faster and more cost-effective.
In addition to greatly improving development time for Web3 solutions, CCIP also brings advantages in security and interoperability.
Protocols do not have to build custom bridges or rely on centralized bridges
dApps can communicate with each other seamlessly
CCIP is like a federated blockchain.
They all come together under the same rules, can enjoy free movement across borders, and communicate more easily than before.
Through CCIP, Chainlink completes 3 main categories of its protocol and DONs:
l Provide verified data
Off-chain computing
l Cross-chain communication
Smart contracts will be able to send messages to each other, use each other’s services, transfer tokens across contracts, and provide clear cryptographic guarantees to users through highly verified data, resulting in cross-chain smart contracts.
Another advantage of CCIP is that it will continue to be improved and updated to support more blockchains, features, and defense mechanisms.
In addition to being powered by Chainlink DONs, CCIP also provides additional security through the Active Risk Management (ARM) network.
Introducing ARM Networks
In short, ARM Network is a secondary authentication service that enhances CCIP security by identifying and blocking malicious and anomalous activity.
The Active Risk Management (ARM) network consists of off-chain and on-chain components:
Off-chain: ARM nodes constantly monitor all supported chains to prevent abnormal activity;
l On-chain: Each supported CCIP chain has an ARM contract;
ARM can “bless” or “curse” a message by reconstructing the history of the transaction (Merkle root) and comparing it to the root submitted by DON.
If there is a match, the ARM node "blesses" the root.
However, discrepancies can cause ARM to "curse" the system, halting operation until the problem is fixed.
Therefore, the ARM network is an additional security guarantee that enables CCIP to add an additional level of security in cross-chain transactions.
Additionally, since Chainlink released its stake v0.1 product in December 2022, some speculate that ARM will also be responsible for the slashing of LINK tokens in the final stake product.
The various cross-chain use cases supported by CCIP include:
l Cross-chain lending: lending and borrowing various crypto assets on multiple DeFi platforms on independent chains;
l Low-cost transaction computation: offloading computation of transaction data on a cost-optimized chain;
l Optimize cross-chain returns: Move collateral to new DeFi protocols to maximize cross-chain returns;
Creation of new types of dApps: developers can exploit network effects on some chains while leveraging the computation and storage power of other chains;
l Cross-chain transfer: seamlessly transfer assets and data between blockchains;
l Cross-chain development and collaboration between developers: cross-chain dApps;
For example, Aave and Synthetix have already adopted CCIP and are beta testing new Chainlink features.
Synthetix has been operating cross-chain for some time due to the high cost of running its protocol on Ethereum.
That’s why they have been using Chainlink’s oracles for a long time, preferring a general-purpose secure and reliable solution over custom integrations that don’t scale.
At the same time, after CCIP, the capabilities of Chainlink DONs will continue to expand to support more use cases.
These use cases will include more advanced computations:
l Automated network of smart contracts
l DECO: Allows sensitive privacy computation to be performed in oracle networks
l Fair sorting service: decentralized transaction sorting
These growing capabilities will further improve the oracle network’s role as critical infrastructure to support more trustless applications.
Some questions and things to think about
Connecting the blockchain world is not an easy task and it brings its own set of problems.
Historically, attention has been drawn to the increasing TVS of Chainlink, from $7 billion at the beginning of 2021 to about $75 billion in 2022 (an increase of more than 800%), while the market cap of $LINK has barely changed: from $4.7 billion at the beginning of 2021 to $4 billion today (7.5 FDV).
As a result, many have raised questions about the value capture of the LINK token.
While Chainlink is arguably the most important infrastructure in the crypto world, the LINK tokenomics fail to empower token holders to accrue value.
Among the possible solutions the team is evaluating is the introduction of a staking mechanism for LINK, which could act as a pitfall and alleviate selling pressure from network participants.
Another issue contributing to this disproportion is the potential inflation of LINK supply, which remains uncertain.
In fact, Chainlink is expected to release 7% of the total LINK supply in circulation between Q2 2023 and Q1 2024. This inflation rate is expected to continue over the subsequent 12 months.
However, this percentage is not set in stone as the rate “may vary depending on external factors, such as increases in user fees,” raising some concerns about uncertainty.
Last but not least, the number of Chainlink DONs exceeds 1,000, while Ethereum nodes exceed 300,000.
A more decentralized oracle network can provide greater security and redundancy.
Last but not least, Chainlink is currently a permissioned protocol and Chainlink Labs is a centralized entity.
Therefore, development is primarily done and directed by Chainlink Labs, which raises some issues related to centralization.
The team has plans to eventually decentralize the protocol, which of course comes with execution risks.