What is a DeFi oracle?

An oracle is an intermediary service that enriches on-chain smart contracts with outside data. The blockchain accepts the oracle and trusts the information that comes from it, further using it to execute on-chain algorithms.
Oracles serve as third-party information sources that are integrated to the smart contract technology based on blockchain. Through oracles, smart contracts have access to actual updated information that blockchain requires to operate. Generally, this information includes current prices for various assets. It’s important to know that oracles are not data sources on their own, they are intermediary services that bring together information and smart contracts, executing data verification.
At present, most projects operating within the decentralized finance ecosystem use oracles to feed their systems with relevant information. To understand how popular oracles are, it’s enough to say that only three out of ten leading Dapps don’t use oracles, while the rest of them strongly rely on oracles that work in a centralized or partially centralized manner as there are practically no oracles providing external data without centralized authority.
Blockchain-based system depend on oracles as they are not designed to store and update on-chain data. To operate properly, blockchains need to use relevant information that would be updated once there’s any change. On-chain systems access the data that is generally stored on large cryptocurrency exchanges — be it Gemini, Binance, or any similar exchange, with one condition that it must have specialized programming structures enabling the use of oracle layers.

What types of oracles are there?

What is the purpose of a decentralized oracle within the DeFi ecosystem?

What are the main challenges for oracles within the DeFi space?

Whatever good oracles make for DeFi projects, there are precise problems related to their use that still have to be addressed.
The main problem with oracles in the DeFi space is a trust issue that emerges when centralized external systems get integrated with decentralized smart contracts and on-chain protocols. Oracles play an important part in the functioning of the smart contracts because these algorithms rely in their operation on the data carried in by the oracles. Thus, oracles have a certain power over the smart contract technology. In this regard, it is essential for the proper functioning of decentralized applications and algorithms that oracles provide credible data with minimum delays possible.
In a more general way, oracles can be divided into two groups: those with low latency and low security and those with high latency and high security. Decentralized oracles are often characterized with high speed. Interestingly, most oracles running applications in the DeFi space are centralized or partially centralized due to high susceptibility of their decentralized fellows to hacker attacks as they work on the basis of game theory principles.
The game theory underpinning the operation of decentralized oracles means that various information sources participate in the process of data collection without any integration or interdependence among them. As there’s no connection among these multiple informers, these data providers transmit as credible information as they can relying on other sources to act in the same fashion. This process has its own pain points such as probable conspiracy among information sources and other malicious actions including bribery. If the system gets hacked with a cyberattack, also known as machine-in-the-middle attack, and the hacker alters the original system arrangements, there’s no retribution instrument in force. Even a slightest change in the network can cause serious damage to the everyday operation of the decentralized applications backed by the hacked oracle.
Centralized oracles are featured with high latency and high security, which means they operate slower, but offer higher data protection options. In comparison to decentralized ones, centralized oracles are steadier in their interaction with independent system elements. They offer voting options and additional layer of security to avoid hacker attacks and any consequences if such attacks take place. Yet, enforced security measures require longer periods of data processing and transmitting, up to weeks, which is the primary reason for many Dapps to refuse to use them as an information feeding instrument. Protected enough from game-theory driven cyberattacks, centralized oracles are vulnerable to hacker attacks thorough the central node, which lowers the security level of the DeFi application using it.

How do decentralized applications solve oracle-related problems?

What are the biggest names in DeFi operating on blockchain oracles?

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