Decentralized Oracles

Decentralized oracles are an essential part of trustworthy transactions on decentralized finance (DeFi) systems. They securely pipeline off-chain data into the blockchain and thus enable smart contract executions [1]. Decentralized oracles can be operated by third-party providers or by the blockchain network itself, and they retrieve data from various sources such as APIs, IoT devices and other blockchains.

According to ConsenSys [1], decentralized oracles bridge on-chain and off-chain information, providing decentralized applications with access to real-world data and events that cannot be directly recorded on the blockchain. For example, decentralized exchanges (DEXs) rely on decentralized oracles to provide accurate pricing information for trading pairs. Other use cases, such as prediction markets, insurance contracts and supply chain management rely on decentralized oracles [2].

Decentralized oracles leverage blockchain technology to build a secure network of data providers. These can be incentivized to submit accurate information by staking tokens or participating in a consensus mechanism. Using multiple data sources and consensus algorithms ensures that the data received by the smart contract is accurate and tamper-proof.

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Outside of DeFi, there are several applications for decentralized oracles. They can be used to verify the conclusion of in-game events, such as the completion of a quest or the outcome of a multiplayer match [3, 4]. Oracles may also be used in supply chain management to trace the flow of items and confirm their authenticity, boosting transparency and lowering the risk of fraud. Another possible application is insurance, where oracles can automatically activate payouts in the event of a predefined trigger, such as the cancellation of a flight or a natural catastrophe [5]. Ultimately, decentralized oracles have the potential to transform a wide range of business and industrial practices by increasing efficiency, lowering costs and improving transparency.

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Classification:

Decentralized oracles are an important component of the blockchain ecosystem, allowing smart contracts to access external data in a safe and trustworthy manner [1,2]. There are various types available, their specific profiles making them more suited to certain contexts.

Hardware oracles are physical devices, which makes them ideal to retrieve and send real-world data. Software oracles work similarly and are more versatile, but they’re also extra vulnerable to corruption and attacks [2, 5]. Consensus oracles use a network of nodes to agree on data validity, providing excellent accuracy and security. Blockchain-based oracles, in turn, operate directly on a blockchain, allowing for transparent and safe access to external data [2].

There’s a type of decentralized oracle that uses human judgment to validate data integrity. Human oracles are especially effective for applications that need subjective judgments or where other forms of oracles may not be appropriate [2]. For instance, a prediction market may utilize a human oracle to arbitrate disagreements regarding the result of an event that cannot be resolved by a hardware or software oracle. In this instance, a group of users may be chosen to serve as the human oracle and render their verdict on the result of the event.

Oracles can also be categorized into centralized and decentralized ones. Centralized oracles are managed by a single entity and rely on a central control point to access and verify external data [2]. While this approach can offer high accuracy and speed, it also introduces the single point of failure issue and the potential for manipulation or censorship. In contrast, decentralized oracles are not managed by a single entity and rely on a network of nodes to retrieve, verify and transmit external data. This ensures that the data is verified by multiple sources and is harder to temper.

Each type of oracle has its strengths and weaknesses, and the choice of oracle will depend on the application's specific requirements. However, it is important to note that using decentralized oracles is critical to ensuring the accuracy and security of smart contracts, making them a key component of the blockchain ecosystem.
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Importance of Decentralized Oracles:

DeFi is a growing field that aspires to make financial systems more open, transparent and accessible. One of the most significant obstacles for DeFi applications, however, is gaining access to dependable and trustworthy external data [6].

Decentralized oracles provide that safe and transparent access, enabling DeFi apps to conduct complicated financial transactions and automate business processes by acting as a bridge between blockchain-based smart contracts and off-chain real-world data sources.

Price feeds, which are used in DeFi to establish asset values, compute interest rates and trigger liquidations, are a fantastic match for decentralized oracles. These can allow the user to retrieve pricing data from numerous sources, check its correctness and communicate it to the blockchain [7]. As mentioned previously, insurance and prediction markets are also made possible by decentralized oracles. Insurance products require access to real-world data [7], such as weather or flight information, to establish if a claim is genuine, while prediction markets rely on oracles to predict the outcomes of events such as elections or sporting events.

The significance of decentralized oracles, however, extends beyond DeFi. They have the potential to jumpstart and empower a wide range of blockchain-based applications, such as supply chain management and identity verification. By providing a safe and transparent means to access real-world data, decentralized oracles can help accelerate the mainstream adoption of blockchain and provide new opportunities.

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Challenges and Limitations

The problem of trust is a significant barrier for decentralized oracles. Unlike centralized oracles, which rely on a single trusted source for data, decentralized oracles acquire and validate information across a network of nodes [1, 2]. This makes it difficult to verify the quality and dependability of data in smart contracts.

Interoperability and scalability are two major concerns. First, different blockchain networks and protocols employ different solutions, so guaranteeing the compatibility of decentralized oracles can be complicated [8]. Second, the number of smart contracts and blockchain-based apps will grow as the need for the technology increases. Making sure that decentralized oracles can manage this while retaining high accuracy and dependability will be an important challenge [9].

Lastly, when employing decentralized oracles, cost is a crucial consideration. The computing resources needed to run decentralized oracle networks might be significant, resulting in hefty operational expenses [3, 7]. Discovering strategies to lower these expenses while retaining the security and quality of the data input into smart contracts will be critical in the future.

Thus, while decentralized oracles provide a potential alternative for accessing real-world data within blockchain-based applications, overcoming the aforementioned issues and limits is indispensable to their long-term success and broad acceptance.

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Future of Decentralized Oracles

The future of decentralized oracles looks promising, with several advancements and developments in the process. According to a report by CoinTelegraph [8], decentralized oracles are expected to feature more prominently in the coming years, especially in the DeFi space where it is essential to access real-time market data. The report also suggests that there will be a move towards more complex oracle systems that can provide more diverse data inputs and a greater emphasis on privacy and security.

Additionally, the review by Al-Breiki et al. [9] highlights the importance of research and development in trustworthy blockchain oracles. The study identifies several open research challenges, such as improving the accuracy and reliability of oracles and enhancing their scalability and interoperability. As blockchain technology continues to evolve, it is clear that the development of decentralized oracles will play a significant role in shaping the future of the web.

In web 3.0, using decentralized oracles will help bring greater transparency and reliability to a wide range of applications and systems, such as supply chain management, identity verification and gaming. By enabling smart contracts to interact with real-world data and events, oracles will facilitate the creation of  more complex and sophisticated decentralized applications. In web 5.0, which is still a theoretical concept, decentralized oracles are expected to play an even more important role in enabling truly autonomous and decentralized systems. Oracles will help to bridge the gap between physical and digital systems, allowing machines to interact with the real world and make decisions based on real-time data feeds.

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Conclusion

Decentralized oracles are becoming a key feature of the blockchain ecosystem, allowing smart contracts to interface with the outside world safely and transparently [8]. They help set up connections between on-chain and off-chain information, allowing decentralized apps to access real-world data and events that are not directly recorded on the blockchain, and to perform complex financial transactions while automating corporate operations.

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References

[1]. ConsenSys. (n.d.). An introduction to decentralized oracles. ConsenSys. https://consensys.net/blog/blockchain-technology/an-introduction-to-decentralized-oracles/
[2]. Binance Academy.(2021). What are decentralized oracles and how do they work? Binance Academy. https://academy.binance.com/en/articles/what-are-decentralized-oracles-and-how-do-they-work
[3]. CoinDesk. (2019). Why decentralized oracles matter for smart contracts. CoinDesk. https://www.coindesk.com/why-decentralized-oracles-matter-for-smart-contracts
[4]. Chainlink. (2021, July 16). Decentralized Oracles: The Missing Link for Web3 Applications. Medium. https://medium.com/chainlink/decentralized-oracles-the-missing-link-for-web3-applications-2a4a49f95c17
[5]. M. Merlini, N. Veira, R. Berryhill and A. Veneris, "On Public Decentralized Ledger Oracles via a Paired-Question Protocol," 2019 IEEE International Conference on Blockchain and Cryptocurrency (ICBC), Seoul, Korea (South), 2019, pp. 337-344, doi: 10.1109/BLOC.2019.8751484.

[6]. Defiant. (2021). Decentralized oracles and their role in DeFi. The Defiant. https://thedefiant.io/decentralized-oracles-and-their-role-in-defi/
[7]. Medium. (2019). Challenges faced by decentralized oracle networks. Medium. https://medium.com/@intellyze/challenges-faced-by-decentralized-oracle-networks-2090b5a06a6c 

[8]. CoinTelegraph. (2020). The future of blockchain oracles. CoinTelegraph. https://cointelegraph.com/news/the-future-of-blockchain-oracles 

[9]. Al-Breiki, H., Rehman, M. H. U., Salah, K., & Svetinovic, D. (2020). Trustworthy blockchain oracles: review, comparison, and open research challenges. IEEE Access, 8, 85675-85685