Blockchain Oracles: Ecosystem around smart contracts — meaning, implementation and status quo

With the discovery and introduction of blockchain technology, new business model potentials arise, which are often related to so-called “smart contracts”. Translated, the term stands for smart contracts that can be executed without any human intervention. People are only needed for programming or “setting up” these smart contracts (cf. Fraunhofer Institute, 2017, p. 8). — Authors: Duc Au, Dirk Stein

1. What is a smart contract?

It follows a certain if-then logic (cf. Ethereum.org, 2021). If, for example, rent has been paid to a landlord, the payer then has access to the rented apartment. Another example relates to notaries. When the purchase price for a property has been paid, ownership is transferred. The latter example in particular shows that blockchain technology is able to significantly change the role of third parties or financial intermediaries.

Since the blockchain is a decentralized network that collectively controls the execution of smart contracts, this form of business is considered very secure and therefore trustworthy based on current knowledge (cf. Cointelegraph, 2021). This is ensured by a common consensus mechanism, which can vary depending on the existence of a blockchain. The best-known consensus mechanism “Proof-of-Work” is used on the Bitcoin blockchain. Put simply, there are so-called nodes (nodes) in a blockchain network, each of which controls and validates each individual smart contract. Exemplary blockchain networks that enable automated trades are Ethereum and since September this year also Cardano, which can be traced back to the long-awaited Alonzo update. The update represents the final step of the Goguen rollout, bringing smart contract capability to the Cardano blockchain. The Goguen phase represents the third of a total of five planned development stages of the proof-of-stake blockchain network. (Cf. BTC-Echo, 2021; Roadmap.Cardano, 2021).

Figure 1 shows the main differences between classic and blockchain-based contracts. With the usual contracts, it becomes apparent that the contract review must always be carried out by employees. These ultimately decide whether a contract is concluded or not. There is therefore a dependency on a third party.

Figure 1: Functioning of Smart Contracts; Source: Bitcoin2Go

On the other hand, there are the smart contracts, which can check themselves automatically and come to a decision. There is therefore no need for an additional human instance to carry out an examination. Various advantages can be derived from this (e.g. more cost-effective contracts, greater trust, more efficient transactions, faster processes and handling, low or no susceptibility to errors).

2. The role of blockchain oracles

3. Decentralized data oracles for financial operations

Three important principles apply to the respective data oracles. First, the correctness of the data provided must be ensured (data integrity). Second, the data must always be available so that transactions and contracts can run smoothly at all times (data availability). The third and last principle deals with the discreet handling of data and contract content (data confidentiality). Full fulfillment of all the above principles is important to enable the smart contracts between unknown parties (cf. BTC-Echo, 2021).

A decentralized oracle network is a group of independent blockchain oracles that provide data for a blockchain. Each independent node or oracle in the decentralized data network independently retrieves data from a source outside of the blockchain and “imports” it into the technical world. The data is then aggregated to allow the system to arrive at a deterministic truth value for that data point. This is of great importance as determinism within a network is crucial for the correct execution of smart contracts (Cf. Coinmarketcap, 2021).

The blockchain platform Chainlink is working on setting up a decentralized trading platform for oracle services. The developers rely on the second largest blockchain platform, Ethereum. Chainlink represents a conscious approach to sorting the offering of Oracle services via blockchain and thus creating trust in the data service. The decentralized blockchain project achieves this by evaluating the oracle service providers based on the three data principles mentioned. Chainlink also supports bringing together the right data oracles for the corresponding smart contracts (cf. Cryptolist, 2021).

4. Status Quo and outlook

This can result in advantages for end customers, which result, for example, in lower transaction costs and faster business transactions and new blockchain-based business models. From the point of view of companies or banks, for example, there is enormous potential in increasing the efficiency of internal processes. From today’s perspective and given the current market developments, the scenario in which banks or other financial intermediaries are completely or partially supplanted by smart contracts seems to be a long way off.

Remarks

About the authors

Dirk Stein is Professor at the FOM Hochschule für Oekonomie & Management and is a research group leader at the Institute for Strategic Finance for digital transformation and digital entrepreneurship. Dirk Stein’s professional stations included various research institutes at RWTH Aachen University, General Electric and KPMG. His main topics are sustainable operating and business models for the digital economy. Stein publishes together with Prof. Dr. Tobias Kollmann annually the Dax Digital Monitor (www.dax-digital-monitor.de).

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