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Blockchain technology needs smart contracts and, above all, their data. Some can run on data on the blockchain, but others need to be fed from trusted data sources from outside your network. This is where oracles come into play. Oracles allow devs or developers to create smart contracts, opening the blockchain ecosystem to the decentralized world. If a smart contract needs to know a specific piece of data, an oracle will provide it with that data. It is a technological meter on a global scale.
Oracles are the foundation for DeFi platforms. Such platforms are based on accurate and verifiable data. Therefore, oracles feed smart contracts with the information they need to execute. This converts the data out of the string into an accessible format. If a smart contract needs to know the value of an asset, an oracle provides that data. The accuracy and relevance of the data determines the value of the smart contract, whatever its use.
In case of data manipulation or erroneous data, the smart contract loses its value. Also, if the data trail is not auditable and the methodology and sources are not transparent, the source of the error cannot be easily corrected. That is why the design of the oracle is so important. Each approach has its own advantages that must be considered. We mainly talk about factors such as centralization, transparency and governance.
Oracles can be categorized according to different qualities. The same oracle can fall into several categories:
1) Source: Where the data originates (software or hardware).
2) Direction of the information: If it is incoming or outgoing.
3) Trust: Centralized or decentralized.
Oracle Software: Software oracles interact with online sources of information and transmit it to the blockchain. This information may come from databases on the web. The fact that software oracles are connected to the internet not only allows them to feed information to smart contracts, but also to transmit that information in real time. This makes them one of the most common types of blockchain oracles.
Information typically provided by software oracles can include exchange rates, digital asset prices, or real-time flight information.
Oracle Hardware: Some smart contracts need to interact with the real world. Hardware oracles are designed to obtain information from the physical world and make it available to smart contracts. This information can come from electronic sensors, barcode scanners, and other information reading devices.
A centralized oracle is controlled by a single entity and is the sole provider of information for the smart contract. Using a single source of information can be risky: the effectiveness of the contract depends entirely on the entity that controls the oracle. Furthermore, any malicious interference from a bad actor will have a direct impact on the smart contract. The main problem with centralized oracles is the existence of a single point of failure, which makes contracts less resistant to vulnerabilities and attacks.
Decentralized oracles share some of the same goals as public blockchains: avoid counterparty risk. They increase the reliability of the information provided to smart contracts by not relying on a single source of truth. The smart contract queries multiple oracles to determine the validity and accuracy of the data, so decentralized oracles can also be called consensus oracles.