One of the most challenging parts of managing a blockchain is administering the division between off-chain and on-chain data. An oracle is a helpful tool that simplifies connecting information from the real world with blockchain activities. Thanks to oracles, users can use blockchains in countless ways in their daily lives. In this blog, let’s learn more about this interesting concept and important things related to it.

What is Blockchain Oracles?

A Blockchain Oracle is a mechanism that allows a blockchain to interact with data and events that occur outside of the blockchain. In other words, it acts as a bridge between the blockchain and the real world.

As we know, blockchains are designed to be immutable and trustless, which means they cannot access data sources or events outside the blockchain network. However, many Decentralized Applications (DApps) require access to external data, such as price feeds or weather reports, to function properly. This is where oracles come in.

An oracle is a trusted source of information that can feed external data into a blockchain. Oracles can be centralized, meaning that a single entity controls the data feed, or decentralized, meaning multiple sources contribute data to the blockchain. Decentralized oracles are preferred because they are more secure and resistant to manipulation. (More details in the following sections!)

Basically, Blockchain Oracles enable blockchain networks to interact with the real world in a secure and decentralized manner, opening up new possibilities for Decentralized Applications (DApps).

Working of Blockchain Oracles

Since Blockchain Oracles are third-party computerized systems, they all have slightly different mechanisms. The majority of oracles, however, use the same fundamental concept. They operate like the blockchain version of an API. Oracles are a layer that interacts with the blockchain; they are not a component of it or the data source itself. This layer makes a request to an external data source for the desired data.

The oracle sends the verification to the blockchain when the information has been verified. There are several uses for the information once it is inside the closed blockchain system. Usually, after particular data is provided, the blockchain is told to validate a smart contract automatically. Oracles can also be used to carry out many kinds of blockchain transactions and operations, such as sending data from the blockchain back into the real world.

So, this was about the definition and working of Blockchain Oracles. Now, let’s see why they are considered important.

Importance of Blockchain Oracles

• Access to external data: Blockchains are designed to be self-contained, which means that they cannot access external data sources directly. Oracles provide a way to bridge the gap between the blockchain and the real world by providing access to data from external sources such as APIs, sensors, or other blockchains.
• Decentralization: Decentralized oracles are preferred over centralized oracles because they are more secure and resistant to manipulation. By using a network of independent data providers, decentralized oracles can ensure that data is accurate and unbiased.
• Trust: By providing a secure and reliable source of external data, oracles help to increase trust in blockchain applications. This is particularly important in industries such as finance, where accurate and timely data is critical.
• Smart contracts: Oracles are essential for smart contracts, which are self-executing contracts that have the terms of the agreement between buyer & seller directly written into lines of code. Smart contracts can only operate on data available on the blockchain, so oracles are needed to provide access to external data that can trigger smart contract execution.
• Interoperability: Oracles can facilitate interoperability between different blockchains by providing access to data from other blockchain networks. This helps create a more interconnected and efficient blockchain ecosystem.

Types of Blockchain Oracles

Hardware and software oracles

Most Crypto oracles analyze digital data, though this isn’t always the case. While software oracles provide data from digital sources like websites, servers, or databases, hardware oracles deliver data from the real world. Additionally, hardware oracles are capable of delivering and relaying data via RFID sensors and camera motion sensors. Software oracles can provide real-time data like exchange rates, price changes, and travel-related information.

Inbound and outbound oracles

With blockchains, Oracles create a two-way communication channel through which they send and receive data. Inbound oracles are more likely to bring off-chain (or real-world) data to the blockchain than outbound oracles, which can deliver blockchain data to the outside world. The imported data can also represent a wide range of things, including changes in asset prices, weather patterns, and the confirmation of completed payments.

A basic programmable scenario for inbound oracles may be: If an asset hits a certain price, place a buy order. On the other hand, outbound oracles notify the outside world of an event that took place on-chain.

Centralized and decentralized oracles

A sole entity controls a centralized oracle and serves as the only data source used by a smart contract. However, it can be risky to rely entirely on one source of information because the effectiveness of the oracle is purely dependent on the entity in charge of the oracle.

A hostile intervention by a bad actor will also directly impact the smart contract. Centralized oracles have a single point of failure, which is the primary issue as it leaves contracts more open to attacks and vulnerabilities.

Several objectives of decentralized oracles are similar to those of public blockchains, like minimizing counterparty risk. For example, by avoiding reliance on a single source of truth, they increase the reliability of the data given to smart contracts.

Decentralized oracles are also called consensus oracles since the smart contract consults several oracles to evaluate the validity and accuracy of the data. Some Blockchain Oracle projects offer decentralized oracle services that other blockchains can utilize.

Human oracles

Sometimes oracles might be people who have specialized knowledge in a certain field. They might collect data from numerous sources, validate it, and turn it into smart contracts. The likelihood of a fraudster impersonating a human oracle and providing modified data is low because they can use encryption to confirm their identity.

Contract-specific oracles

These oracles are designed to function with single-use smart contracts. However, it will be necessary to build several contract-specific oracles if the developer plans to deploy numerous smart contracts.

Oracles that are only applicable to contracts are not worth the time and effort required to maintain them. Instead, they are inconvenient and ought to be used only in certain circumstances.

Computation oracles

So far, we have discussed oracles in terms of their use in gathering and providing data (also called data carrier oracles or automated oracles). But with Ethereum’s built-in block gas constraint and extremely high computation cost, oracles can be utilized to conduct any arbitrary “off-chain” compute solution.

Instead of merely relaying the results of a query, computation oracles can be used to compute on a set of inputs and deliver a calculated result that would be impossible to compute on-chain otherwise. For example, a computation oracle may be used to carry out a computationally challenging regression calculation to estimate the yield of a bond contract.

Conclusion: Can Blockchain Oracles be fully trusted?

By incorporating outside data into the equation, oracles play a crucial part in the execution of smart contracts. On the other side, oracles present a serious risk since, if they are regarded as reliable sources and are vulnerable to hacking, they could jeopardize the successful execution of the smart contracts they support.

In general, the trust model must be properly taken into account when thinking about using an oracle. If we assume the oracle can be trusted, then you may be risking the security of the smart contract by exposing it to potentially wrong inputs. Oracles can be useful, though, if the security assumptions are carefully taken into account.

Disclaimer: Cryptocurrency is not a legal tender and is currently unregulated. Kindly ensure that you undertake sufficient risk assessment when trading cryptocurrencies as they are often subject to high price volatility. The information provided in this section doesn't represent any investment advice or WazirX's official position. WazirX reserves the right in its sole discretion to amend or change this blog post at any time and for any reasons without prior notice.