Blockchain technology and smart contract development have limitations when it comes to connecting with information in the real world. That is, separating on-chain and off-chain data. As a result, a system known as blockchain oracle is required to bridge the gap and connect on-chain, which is every interaction that occurs on the blockchain and off-chain data.

Blockchain oracle serves as an interface, allowing blockchain to reach its full potential by facilitating seamless communication between blockchain and various services and external data. So, what exactly are blockchain oracles, and why are they crucial to the blockchain ecosystem?

What Is A Blockchain Oracle?

Blockchain oracles are entities and interfaces that connect blockchains to external systems, allowing smart contracts to execute commands based on real-world inputs and outputs. In other words, blockchain oracles are third-party systems that bridge the gap between data from the outside world (off-chain) and the blockchain (on-chain) while providing smart contracts with external information.

Many oracles are decentralized and can take many forms, enabling the development of hybrid smart contracts that combine on-chain commands and off-chain infrastructure to support advanced decentralized applications (dApps) that react to real-world events such as temperatures, deed transfers or cryptocurrency prices and communicate this data to the blockchain.

Oracles are crucial components of the blockchain ecosystem because they expand the range of applications that smart contracts can use and give the decentralized Web3 ecosystem access to legacy systems, existing data sources, and advanced computations. Smart contracts wouldn't be very effective without blockchain oracles since they would only have access to data from their own networks.

How Do They Work

Blockchains and smart contracts are not designed to communicate with the outside world by design. In more technical terms, they are not designed to access data that does not exist on their network (i.e., offline data). Therefore, blockchain oracles become an essential third-party computerized component in bridging the gap and giving the blockchain a proper way to access both off-chain and on-chain data.

However, it is critical to understand that a blockchain oracle is not the data source itself but rather the third-party layer acting as an interface that queries, verifies, and authenticates external data sources before relaying that information to the blockchain.

To illustrate this, two brothers, Emmanuel and John, are placing a bet on an outcome of a Manchester derby football match. Emmanuel placed $50 on Manchester United, and John placed $50 on Manchester City, with the $100 total held in an escrow by a smart contract. How does the smart contract know whether to pay Emmanuel or John when the game is over? The solution is to use an oracle mechanism to retrieve accurate match outcomes off-chain and deliver them securely and reliably to the blockchain.

If the oracle had not relayed the data, there would have been no way to settle this bet in a way that could not be subverted by one of the participants. As a result, Oracle solves the blockchain's communication problem and enables them to find and access external data for on-chain smart contracts.

Types of Blockchain Oracle

Numerous types of oracles exist; how a blockchain oracle operates depends entirely on its intended use.

Software Oracle and Hardware Oracle

Software oracles interact with online data sources and send them to the blockchain. Online information can come from any source, such as online databases, servers, websites, or any other data source on the Internet.

Software oracles are useful for providing real-time supply chain information to smart contracts. Other important oracle use cases include digital asset prices, real-time traffic information, exchange rates, and many more.

On the other hand, hardware oracles collect data from the physical world and make it available to smart contracts. Electronic sensors, barcode scanners, and other data-reading devices could relay this data. The food supply chain is the best example of a hardware oracle, with a sensor checking if a truck transporting goods has arrived at a loading bay. Therefore, a decision is made by the smart contract with the information received from the sensor.

Inbound and Outbound Oracle

Inbound oracles send data from external sources to smart contracts, whereas outbound oracles send the information generated by the smart contract to the outside world.

So, rather than bringing external data to the blockchain, they send blockchain data to another system. Inbound and outbound oracles are typically the most useful types, as they use real-world situations and external data to influence how a blockchain operates.

Centralized and Decentralized Oracle

A centralized oracle is controlled by a single entity and serves as the smart contract's sole source of information. Using a centralized oracle can be a tricky situation because the effectiveness of a centralized oracle is entirely dependent on the entity controlling the oracle.

On the other hand, decentralized oracles are not controlled by a central entity but rely on multiple sources of truth. Decentralized oracle objectives are similar to those of public blockchains, such as avoiding counterparty risk. As a result, data transmitted through decentralized oracles can be verified and trusted. However, implementing decentralization in an oracle can be difficult because decentralized oracles require consensus from multiple network participants.

Human Oracle

Individuals with specialized knowledge in a particular field can function as an oracle. Human oracles are in charge of researching information and ensuring its authenticity before it is translated and supplied into smart contracts. Human oracles can use cryptography to verify their identity, making the possibility of a fraudster impersonating them and providing corrupted data relatively low.

Contract-specific Oracle

A contract-specific oracle is only used by one smart contract. This means that if several smart contracts are to be deployed, a proportionate number of contract-specific oracles must be developed. However, contract-specific oracles are not worth the time and effort required to maintain them because they are inconvenient and unsuitable for recurring events. As a result, they should only be used in specific situations.

Use Cases Of Blockchain Oracle

• Insurance
• Business entities
• Decentralized finance
• Environmental accountability
• Blockchain gaming and NFTs

What Is The Oracle Problem?

Although the oracle is an important component of the blockchain ecosystem because it bridges the gap between on-chain and off-chain data, it is not without flaws. Therefore, the key concern with oracle design is that if oracle is compromised, the smart contract that depends on it becomes vulnerable. This is commonly known as The Oracle Problem.

Oracles are not protected by the security mechanisms that public blockchains can provide because they are not part of the main blockchain consensus. As a result, compromised Oracle data can leave the smart contract vulnerable.

The Takeaway

Without blockchain oracles, smart contracts would be forced to rely solely on information already present in their networks, severely limiting their capabilities. As a result, blockchain oracles will likely become more prominent as blockchain technology adoption spreads across multiple industries.

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