Table of Contents
Author: Gavin Stein
Oracles are increasingly becoming a foundational 3rd party of the decentralized financial ecosystem (DeFi), providing off-chain data for blockchain smart contracts. The crucial role oracles have to play in the DeFi market has seen the market value for oracles rise to over tens of billions of dollars, with over 80% of decentralized applications needing an oracle. What are oracles, and why are they so important to DeFi?
There are two problems that oracles seek to address. Blockchains that allow smart contracts to run like the Ethereum network cannot support native communications to external network systems which provide information from the “real world.” Secondly, if the oracle network is a centralized protocol running to the blockchain, this defeats the purpose of on-chain. The connectivity issue is not one-sided, however, as smart contracts would not be able to move any data collected on-chain or off-chain. Enter Chainlink: a decentralized oracle network bridging the gap off and on-chain.
Chainlink was founded in June 2017 by Sergey Nazarov and Steve Ellis, providing a middleware between real-world data and data on the blockchain. The components that structure this network are often divided into off-chain and on-chain use. Off-chain, Chainlink operates as an ecosystem of oracle nodes that hook up with protocols on-chain like Ethereum. On-chain Oracle functions as a series of smart contracts that permits requesting data from the off-chain oracle nodes monitoring and running data requests advanced by users, made from three pieces: reputation contract(verifying reputability of data), order-matching contract(matching smart contract orders), and aggregating contract(collecting data from oracles).
Chainlink: The Process
The Chainlink process begins on a smart-contract-enabled blockchain. Smart contracts are, in essence, self-executing contracts agreed upon by a seller and the respective buyer, which are written into lines of code as transaction protocols, with some of the features being these transactions are transparent, cannot be reversed, and can be traced. The smart contract requests information and data off-chain, or Chainlink, is requesting contracts for the information.
Chainlink registers the requesting contracts query creating what is known as an event which concurrently then creates a corresponding Chainlink Service Level Agreement(SLA) to search and collect the off-chain data. Within the SLA, three other important contracts are executed: a Chainlink Reputation Contract, a Chainlink Order-Matching Contract, and a Chainlink Aggregation Contract.
The Chainlink Reputation contracts verify the reputability of the oracle provider by assessing past performance history and evaluating whether the node is reputable or not based on the average of the information from these sources. A real-world example is if 49 out of 50 banks were able to assess the credit history of a particular client, with one bank deeming the client unreliable or disreputable, it would be in the searching bank’s best interest to discard the one bank and continue. Chainlink reputation contracts work similarly; nodes will be used to verify information relating to a source like a weather sensor, with nine nodes having verified the information as acceptable and one node deeming it not acceptable. Then, the Reputation Contract will deem it reputable based on this information.
Chainlink’s Order-Matching Contract processes the log of the user’s proposal on the oracle network, then goes through and collects offers from the oracle providers and then distinguishes them according to the reputation contract analysis, otherwise known as the track record of the oracle-service-provider.
Finally, all the information is computed, processed, and evaluated into one accurate result, validating these into one single source by the Chainlink Aggregating Contract. Once the SLA’s three subcomponents are complete, then Chainlink core software comprised in the nodes translates the on-chain programming language to a data source that can be understood by everyone off-chain, which then routes the newly translated data to an API collecting various data that was requested, API’s could include the Stock Market, FX rate or other others within the industry. A similar process is then carried out once the data has been collected and sent back to the Chainlink Aggregating Contract.
Chainlink: LINK Tokens
LINK is built on Ethereum, and all LINK tokens are created per ERC-20 standards for tokens. LINK tokens are used by Contract holders who request a smart contract to do a certain job by paying node operators from Chainlink the LINK to operate the node for the request. The prices of the Chainlink operator of the node sets are based on the importance of the information provided within the market. Additionally, operators of the Chainlink nodes will stake on the network and deposit LINK as proof of their commitment and incentivize good service within the operation. Choosing to match nodes undergoes the process of utilizing the Chainlink reputation contract to assess the side of the node’s stake when picking the node to pair with for the requested data. Moreover, the greater the stake equates to a higher likelihood to be chosen by the SLA to fulfil the requests, dually earning more LINK tokens for node operators. Lastly, any malicious or disreputable node operators will incur a tax on the node’s stake.
Chainlink: Adoption and Use cases
Chainlink has seen widespread adoption and is the leader in the oracle space. Recent developments can attest to this upward momentum, with Chainlink employing a Verifiable Random Function designed for smart contracts. VRF can be utilized by smart contract developers to provide a tamper-proof RNG for applications where unpredictable outcomes are necessary. Some applications include Blockchain games and NFTs, random assignment of duties and resources, and lastly, choosing a representative sample for a consensus mechanism. Its adoption in Binance Smart Chain(BSC) was an important, relatively recent project to implement Chainlink’s VRF.
Chainlink has also seen adoption as part of the yearn.finance protocol in v2 LINK yVault otherwise known as yvLINK. Within this vault, yearn.finance can supply LINK to Vesper Finance LINK Pool to earn VSP(Vesper LINK), resulting in rewards that can be harvested and then sold with these rewards for additional LINK that will be deposited within the vault. Another development is lending LINK on AAVE, gaining interest, and then staking the accumulated AAVE after as a reward (AaveLenderLINKBorrowerSUSD). Lastly, yearn.finance utilitizes LINK by locking it at MakerDAO via the LINK-A minting DAI, which then uses the minted DAI as a deposit on v2 DAI yVault earning yield(StrategyMakerLINKDAIDelegate).
Chainlink also offers lending and borrowing applications that provide price feeds that can be used to compute collateral values, commitment to loans being issued, and liquidating features according to the market prices. A few notable protocols utilizing Chainlink are Aave’s borrowing and lending of many on-chain tokens, CREAM’s on-chain money market on Ethereum, and Sushiswap Kashi’s lending and margin trading solution, which was created on the BentoBox smart contract.
Chainlink authorizes derivatives markets and synthetic assets by providing to these markets and assets the current price at the settlement or trade. Some protocols involved include Synthetix, one of the largest derivatives protocols, and Opium Exchange, where Chainlink can empower options, credit default swaps, and futures. And lastly, MCDEX, as Chainlink, can provide current pricing for automated market makers and order books.
Chainlink can also provide feeds for prices utilized to settle trades, determine the price associated with a selected liquidity mining collateral, create market strategies, and provide a secure off-chain computation of collateralized value. dYdX is one notable protocol that empowers its services through Chainlink, providing spot trading and perpetual contracts. Another notable protocol is Curve which Chainlink authorizes through its features of automated market-making and low slippage between pegged assets.
Insurance is another area where Chainlink eases the process of providing parametric insurance applications and supporting the protocol’s policy for incorrect rebalancing or payouts for funds that have been insured. Arbol is one protocol that Chainlink facilitates using parametric crop insurance for farmers derived from weather conditions. Etherisc is another protocol, which is Chainlink facilitating real-world flight delays through insurance payouts and settlements.
Pegging assets are additionally utilized by Chainlink, in which they empower protocols by assessing off-chain reserves that can balance on-chain token use and if needed, trigger rebalancing with lost pegs. One example is Paxos, a real financial world brokerage providing real-world assets facilitated by Chainlink. Another example includes TrustToken, a blockchain stablecoin supported off-chain by reserves in USD.
Assets within the real world, such as real estate in RealT, is another area that Chainlink has been utilized to provide current data regarding the asset’s value as they are presented off-chain to a valuation represented on-chain. Chainlink facilitates, in particular, tokenized real estate for RealT and authorizes users to buy parts of a property’s inherent cash flow.
Outside of delivering data, Chainlink can also trigger on-chain events off-chain based on conditions that have been specified prior. B-protocol is one notable example where Chainlink empowers liquidation, making lending more trustworthy by making the protocols secure. Another example is Keep3r which can be used to automate on-chain transactions like liquidations being off-chain.
Lastly, one of the more famous examples in the NFT craze is Chainlink being used for on-Chain collectibles. Chainlink’s VRF, as mentioned above, provides a proven fair source of randomness, which has been used to generate random NFT traits and issue a reward to a user. Etherlegends, Aavegotchi, and Axie Infinity are three protocols that are authorizing Chainlink to facilitate tasks such as collectibles backed by interest-generating tokens, PvP and PvE trading card games, and Pokemon-inspired universes where VRF can be utilized in battling Axies. Additionally, on-chain gaming is another area where Chainlink’s VRF has been utilized to generate immutable random in-game scenarios and prizes. Blocklords, Planetarium, War Riders, and Evolution land are notable examples of Blockchain/cross-chain game applications.
Chainlink: Grants and Research
Chainlink has deployed what is known as its grant program to assist in collecting fundamental resources in the generation of developer tools and high-quality data and launching services in or around the Chainlink Network. Listed on the website are five categories that grants are typically granted. These include community grants, integration grants, bug bounty programs, research grants, and social impact grants.
Integration grants support teams, projects, and protocols globally to become part of Chainlink’s ecosystem by providing services or technologically based work from Chainlink. Notable examples of integration grants include SmartPy receiving an integration grant for Chainlink Price feeds of Tezos, Blockspaces, and LinkUp Florida receiving a Grant to integrate Chainlink on Near Main net and Blockchain integration with Solana and Avalanche.
The bug bounty grant encourages engineers specializing in security or developers who can examine Chainlink’s core code, creating greater stability by searching for attack vectors now and in the future. The research grant supports academics or researchers that can provide cutting-edge research into Chainlink, propelling the network forward. Lastly, the Social impact grants support organizations not for-profit or organizations researching and deploying avenues to utilize smart contracts and data on-chain for the betterment of humanity and the innovative emerging markets.
Chainlink 2.0: What’s New
April 2021 Chainlink 2.0 version of the white paper was released, which saw Chainlink Labs outline new abilities and potentials for the network. These included scalable off-chain computation, explicit staking, and privacy-preserving features contributing towards Chainlink Lab’s long-term vision of becoming a Decentralized Meta layer. As outlined in the white paper, the core functionalities were: hybrid smart contracts, abstracting away complexity, scaling, confidentiality, order-fairness, minimization, and incentive-based crypto-economic security.
While hybrid smart contracts are already being deployed, as mentioned in the Paxos use case above, we will see with 2.0 a scaling of hybrid smart contracts. As termed in the white paper, this evolution will change the existing oracle network into the vision of Chainlink being a Meta layer with the introduction of Decentralized Oracle networks(DON).
Super-linear staking aims to introduce the idea into the Chainlink protocol of a quadratic staking impact that requires potential attackers to have resources that are quadratically greater than the combined security deposits of all the nodes in a decentralized oracle network. Essentially there are explicit incentives in which Chainlink will require two deposits as collateral, one of which can be slashed for malicious behavior. Implicit incentives will include an opportunity cost at the reward that nodes could miss by behaving dishonestly.
Additionally, the scalability of on-chain data was another pressing concern for Chainlink Labs in response to launching Off-Chain Reporting(OCR). It is estimated that OCR will be able to bring ten times more data on-chain while also minimizing costs by up to 90%. OCR was developed by Chainlink’s Chief Scientist Ari Jyels, basically Instead of previously Chainlink oracle nodes pulling data on-chain, which incurred gas fees on Ethereum, now data aggregation can happen off-chain, which can be used for a variety of purposes such as updating Proof of Reserve, and other services such as insurance.