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?

A smart contract is characterized by the fact that it is able to run independently and automatically. This implies that a third party is no longer needed, for example to monitor a transaction between two people or even to ensure the execution of a business. Because blockchain-based contracts can be programmed in such a way that the agreed transaction takes place as soon as one or more (agreed) contractual conditions are met. If the conditions are met, a payment to the recipient is triggered and the contract is automatically terminated.

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

A blockchain oracle is a device or entity that connects a deterministic blockchain to data outside of the technical “blockchain world”. A blockchain is deterministic if the smart contracts are designed in such a way that the same result always appears every time a node checks it (cf. Chainlink, 2021). The following example illustrates determinism: If a smart contract provides for payment between two people at a specific point in time, then this contract is controlled by all existing nodes in the network. It is imperative that every node that validates this transaction comes to the same result. This result can be the payment of EUR 500 from Person A to Person B. If a node came to a different result — for example 450 EUR — then the network can no longer be regarded as deterministic and thus loses its raison d’être as a reliable and trustworthy network. Data for such deals or contracts can now either already exist in the blockchain network (also called on-chain data) or have to be “imported” from the “real world” (also called off-chain data). Examples of off-chain data are current exchange rates, financial investments or commodities (cf. Crypto Valley Journal, 2021). The blockchain oracles discussed here act as a kind of connector or bridge between the technical and the real world. They “import” the data from the real world into the blockchain world so that it can be used to program automated contracts. As with other technologically important fields of application (e.g. artificial intelligence, big data), data quality and quantity play a decisive role in the success of smart contracts (cf. Coindesk, 2020).

3. Decentralized data oracles for financial operations

It has already been pointed out that data is essential for the success of automated trades. It was also emphasized that the strength of blockchain networks lies in their decentralization. By using a specific consensus mechanism, there is no longer a need for a central authority or entity that watches over the network and controls transactions. If you now link these facts, then the legitimate question arises as to whether a single data oracle can meet the decentralized requirements as a data supplier in the blockchain world. This is obviously not the case, as it would contradict the basic idea of decentralization and the abolition of central authorities. Consequently, the emergence of a broad market offering of different data oracle vendors is to be welcomed.

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

Without a doubt, the ecosystem, which represents the cooperation of various companies within the blockchain universe on the subject of smart contracts and data oracles, is still in the starting blocks. The Chainlink blockchain network mentioned is still under construction and has to prove its plans, which are written in the so-called white paper “Chainlink 2.0 — Next Steps in the Evolution of Decentralized Oracle Networks” (cf. Chainlink, 2021 ). However, the first important steps and milestones have already been reached. Not only private customers but above all companies (especially commercial banks) are following the developments of this blockchain application with eagle eyes.

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

The article can be read in German language on it-finanzmagazin.de. Here the direct link to the publication

About the authors

Cam-Duc Au is currently doing his PhD at the Masaryk University in Brno in the field of crypto robo-advisory and, as Manager Holdings at P. Keppler Verlag, accompanies the digitization of the WM Gruppe together with CEO Michael Reuther. He also works as freelance lecturer at FOM Hochschule für Oekonomie & Management in Frankfurt am Main, Essen & Düsseldorf and as Research Fellow at the isf Institute for Strategic Finance. You can contact him via mail (cam-duc.au@fom-net.de), via LinkedIn, or Xing.

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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