Much has been made of the security and immutability of blockchain, but this security comes with a caveat: It can be achieved only when the blockchain is separated from external systems. This means that a smart contract could be set up in a supply chain to tell a company when a shipment is transferred, but it couldn’t make routing decisions based on real-time geolocation data.
As Joel Hugentobler, Cryptocurrency Analyst at Javelin Strategy & Research, found in the report Oracles: The Missing Link Between Blockchains and the Real World, oracles can be the bridge between blockchains and the rest of the world. However, there are many aspects to consider as more organizations, and especially financial institutions, incorporate this technology.
Oracles in the Picture
One of the simplest examples of oracles in action is an online sports bet, such as when two parties bet on the outcome of a football game.
“You connect your wallet, make your bet, and depending on the end score, the oracle would pull that data as soon as the game’s over and automatically send payouts to whoever picked the winner,” Hugentobler said.
Oracles are entities that turn standard smart contracts into hybrid smart contracts — self-executing programs that can react to real-world events and interact with traditional systems.
With oracles in the picture, many use cases emerge. For instance, a hybrid smart contract could be built to trade a stock or bond based on complex market data. Similarly, the smart contract could be instructed to take certain actions within a loan portfolio in response to shifting interest rates.
Another intriguing use case for oracles is in the insurance industry, where weather data is often used to calculate insurance premiums and payouts.
“The oracle could use multiple weather sources if a tornado or a hurricane came through, to validate and verify that an insurance claim needs to be paid out,” Hugentobler said. “It’s just all put on automatic with these oracles, because once these conditions are laid out in the insurance claim smart contract, it’s all executed automatically on-chain and paid out.
“This is great in the case of insurance, where in a lot of these situations it can take months for people to get money. If this can cut time down significantly to a matter of days, that’s huge.”
Making the Intended Decisions
Although there are powerful use cases for oracles, introducing external data into a secure blockchain carries risks. The challenges are similar to those that have affected artificial intelligence — namely, that AI models are only as good as the data they are built upon. If an AI model receives data from a single source, there is a substantial risk this data could be skewed, corrupted, or manipulated.
Oracles face this same issue. When data comes from a centralized repository or a disreputable source, an oracle could provide incorrect data to a hybrid smart contract, resulting in an error or an unintended consequence.
AI has also been a frequent target for bad actors, as evidenced by the recent exploitation of Google’s Gemini platform and hacking attacks against Microsoft’s Copilot. With nearly every AI platform that has been introduced, cybercriminals have attempted to hack it or find loopholes within it to help them carry out illicit activities.
Oracles and smart contracts — especially those that perform financial operations — will also be targets for bad actors. This is one of the main reasons it is imperative to decentralize oracles and to ensure they retrieve their data from multiple trusted sources.
Some of the top oracle companies, like Witnet, Paralink, and Provable, have developed a model designed to mitigate these risks. In these platforms, oracles are made up of a smart contract and off-chain infrastructure that queries APIs and constantly updates the data in the hybrid smart contract.
However, the leading oracle solution, Chainlink, has taken this a step further. The platform is a decentralized network not specific to any blockchain. The objective of Chainlink is to collect all of the external sources for its oracles into what is effectively an on-chain library. Oracles can then reference this single framework, ensuring smart contracts have the best chance of making informed decisions.
Overhauling the Infrastructure
Over the past few years, digital assets have become a central focus for financial institutions. Stablecoins and tokenized deposits have featured in the strategies of many banks and credit unions seeking to leverage this nascent technology.
However, blockchain is at the heart of all these technologies. To truly leverage digital assets, more financial services firms must explore smart contracts and oracles. However, there is an additional consideration for these organizations.
“There are always risks,” Hugentobler said. “There is obviously smart contract risk if something doesn’t execute. There are risks of funds being lost or sent to the wrong address or something like that, but I think one of the biggest risks is integrating this stuff into existing systems.”
Oracles are a middleware solution, so they don’t require any hardware implementation. Still, integrating oracles and hybrid smart contracts could present a challenge, depending on the institution’s systems.
“I think the infrastructure still needs to go through an overhaul for this stuff to really make a difference, because I think one of the biggest things is providing transparency to the end user of the financial institution,” Hugentobler said. “Once that’s built out, though, I think this stuff is pretty seamless.”
