Blockchain technology has come a long way since its inception. Today, people from all over the world have embraced this technology to the extent that newer technologies have already started being implemented on top of this framework. One such implementation of blockchain technology is Decentralized finance or, as it’s popularly known, DeFi. Decentralized finance is seeing a serious boom today because its disruptive power to the traditional brick and mortar banks is very apparent. The finance and banking industry is worth billions of dollars worldwide. By accepting and promoting decentralized finance, the industry has gone from holding $547 million in assets last year to more than $12.4 billion. Although this technology’s use is virtually unlimited, the base is not as strong as it needs to be. One major issue is that of oracles, which are quite important in a decentralized structure. Let’s take a closer look at the importance of effective oracles for the success of DeFi powered projects.
The role of oracles in DeFi
Decentralized finance products run using smart contracts. These contacts allow for the automation of processes when particular conditions are met. On the other hand, smart contracts are basically blocks of code placed on the blockchain to handle financial activities on decentralized apps (Dapps). For instance, you can create a smart contract that sells your shares in a particular company when the price per share reaches a certain number. Or buys a certain number of shares if the prices dip past a certain number. When these elements are in place, they eliminate the aspect of human decision making. However, to accomplish this, these smart contracts need verifiable data on which they can then act upon. As such, an interface is needed to push data from a particular source onto the smart contracts. This interface is the “Oracle.”
What does it take to have an effective oracle?
Just like with all automated processes, the correctness of the information can determine whether a task is implemented correctly or not. Especially in matters about finance, accuracy is very important. Blockchain transactions, once completed, cannot be reversed. Incorrect information pushed onto the smart contracts can result in losses that have no remedy.
To ensure that everything works correctly, oracles must then gather data from various sources, consolidate it, and then push it onto the smart contracts on verification of accuracy. This is why having a centralized oracle is never a good idea. Although they are easier to oversee, they have higher latency rates meaning that data cannot be accurately retrieved fast without any errors. A decentralized oracle is more advantageous because not only are they better protected from malicious persons, but also they don’t have a single point of failure that would make it easy for targeting. Experts say that should an oracle be compromised, the person controlling it can manipulate the data as they want, which can seriously compromise the security protocols in place. On the other hand, decentralized oracles are very fast, which provides a DeFi network for some wiggle room.
The dangers of centralized oracles
Despite decentralized oracles being more prone to game theory attacks, they are fundamental for DeFi’s success. Apart from their idealistic benefits, decentralized finance is better protected because no one party can choose the direction in which certain rates it can move. For instance, in centralized finance, the banks determine exchange and interest rates, which is ideal for making them money. By decentralizing oracles, we make sure that no one oracle handles all the data. As such, it becomes difficult for the data to be changed, which is a huge credit for transparency champions.
It’s also important that these decentralized oracles also have a mechanism in place to verify the information being handled by these oracles. They can collaborate the data with external independent sources to ensure that security is not compromised and that people remain confident in this technology.