DeFi Escort: The Importance of Oracles
source | hackernoon
Author | Charles J Read
Most people who pay attention to the blockchain should have heard of DeFi, and those who understand how to use it understand what DeFi means-but there is another aspect that is understudied, and that is price oracles and their Impact on DeFi applications.
An oracle is a third-party service that provides a smart contract with the data it needs to execute, usually associated with a price.
Before exploring some emerging solutions, I will first analyze some popular DeFi projects and the oracle systems they are using, such as their advantages and disadvantages, and then give some advice on how to build a fair oracle / data retrieval ecosystem suggestion.
Traditional financial systems require intermediaries and thus present a single point of failure. They are prone to corruption, fraud, security incidents, etc. Smart contracts and decentralized networks give us the opportunity to rebuild these systems, which are accessible to ordinary people, and can improve traditional financial products built on top of these systems, especially in terms of lending.
DeFi provides us with a new, transparent financial system that does not rely on intermediaries
A common theme of DeFi products is its hybrid protocols that keep instability out of the equation while offering the benefits of a decentralized network. This is achieved by combining crypto assets with traditional assets, especially those tied to the U.S. dollar.
MakerDao is the most well-known example, which uses a hybrid system to maintain an average 1DAI=$1 ratio and requires mining DAI (tokens worth $1) by locking up volatile assets. There are other hybrid systems that use concepts like "supply elasticity" like Ampleforth or the now-sounding old Diameter Base Protocol. In response to changes in demand, they adjust the circulating supply through the Rebase mechanism.
The purpose of using the rebase mechanism is to continuously balance demand through circulating supply, thereby maintaining price stability, but this mechanism does not work well when the market is in a state of frenzy, as we have experienced recently. The price of Ampleforth skyrocketed to an all-time high, and due to a bunch of aggressive rebase measures (i.e. airdropping tokens to holders), once the price started to go downhill, it fell fast and hard.
The oracle machine is the foundation of the entire ecology, because all applications depend on accurate data.
Compound is another DeFi product that allows assets to be borrowed and lent against collateral, with interest rates adjusted according to the needs of the borrower/lender.
The Compound network is governed by COMP holders, who can vote on the future development of the network through a proposal system - the more tokens they hold, the greater the weight of the vote. This will have interesting results with the number of admins.
It sometimes calculates an average based on multiple oracle reports, and if there aren't that many admins providing data, it can calculate a wrong price that can severely impact a large number of borrowers/lenders.
As DeFi products take off, ChainLink is the clear winner
Over the past 18 months, the use of oracles has exploded and is being used by some of the most influential DeFi teams, including Kyber Network, Fulcrum, Opium Network, Synthetix, and more. A key advantage of Chainlink is that it uses multiple oracles to derive its price. Bzrx had an accident recently because it only relied on price data provided by Kyber Network. This means, a sudden drop in Kyber creates a situation where Bzrx liquidates its positions. With Chainlink, there is a decentralized supply of price data, which can avoid this from happening.
research reportresearch report, Synthetix's ETH/USD oracle data has an average 2% deviation from regular prices.
While this is a high bar for now, we have to work towards more accurate price feeds and a more dynamic system, which of course is what Chainlink is doing, but wouldn't it be nice to have healthy competition?
At present, most price flow oracles often deviate from the actual data.
A deviation of a few percentage points may not seem like much, but when we structure a financial system that provides information on lending, liquidation events, and interest rates, we need accurate numbers.
The notorious “flash loans” or quick liquidation events in DeFi products are often related to price oracles
If I have a DeFi product and pull its price up to, say, the price of BAT on an exchange, and people are borrowing this DeFi product at the price of BAT, then it only takes a big sell on that exchange. Any leveraged BAT position can be liquidated.
And the use of multiple data streams and aggregators can greatly reduce the risk of troublemakers with the ability to move the market quickly.
There are some new contenders in the DeFi oracle space
DIA is known for building an ecosystem that provides open financial data for smart contracts. It offers multiple price streams and draws data from multiple sources including exchanges, other blockchains, European Central Bank FX rates, ITINs (International Token Identification Numbers),SONIA、SOFR& €STR Overnight Rates (secured overnight funding rates in USD and overnight risk-free rates in euros).
They aim to be a "Wikipedia for financial data," meaning that the data can be voted on by the community in an open-source format, rather than decided by a central committee. DIA does not manage, acquire or verify data internally, instead, these activities are carried out by its token holders through cryptoeconomic incentives and pledge of its governance currency. This design greatly improves transparency and is a bottom-up system for cleaning, aggregating and transmitting financial data to the API and Ethereum's oracle system.
This database can handle a variety of different data streams, from high-frequency trading APIs, all the way to never-changing and inaccessible data in high-performance key-value databases.
The interesting thing about DIA is that it supports a variety of traditional financial data and encrypted market data at the same time, and can customize exclusive price data according to user requirements.
The above-mentioned paper by Bowen Liu and Pawal Szalachowski pointed out that the lack of transparency in the oracle systems used by applications such as Synthetix and Compound makes it difficult for them to detect improper operation. when in aCryptoDiffer When asked directly during the AMA what advantages DIA has over its competitors, Paul Claudius of the DIA Data Team replied:
“We are not a new database that provides complex price models, instead we focus on a Wikipedia-like approach where everyone can participate and comment on the work of the community for the sake of the community. We provide data providers and digging Community members of data sources issue our governance tokens as incentives.”
In the coming months, it will become a DAO run by the community. Our team (or the wider community) can then start creating DeFi products based on this data ecology, and the price feeds they use will be frequently audited by the community.
But what makes a good oracle? The following are some evaluation indicators
I think the article is written so far, it is time to talk about "what is a good oracle machine" and "how can we build a good data system". The factors listed here are not all, but can help readers better understand which direction we should develop.
governance
Internal vs external: Is this oracle built specifically for a certain protocol/application, so it is governed by that community? Or is it readily available to any third party?
Choice of Computation: Who chooses the methodology for computing oracle values? The computing models of oracles are usually different, and according to my previous research, it is risky for administrators or ticket hoarders to determine the oracle logic. Can users select multiple on-chain price streams and aggregate them?
Changes in the oracle: How is the change in the oracle itself determined? This includes the release of new contracts, changes in aggregation data methodology, and sometimes complete removal of some data sources. Some oracles require "administrators" to make decisions. Is this fair?
Data source: Is the documentation of the oracle machine transparent enough that users can easily retrieve the source of the oracle data? Sometimes this information can be found in white papers, but real-time data is often missing.
transparency
transparency
Data source: Is the documentation of the oracle machine transparent enough that users can easily retrieve the source of the oracle data? Sometimes this information can be found in white papers, but real-time data is often missing.
Methodology: Is the exact methodology for calculations, data sourcing, and data aggregation easily retrievable and clearly documented? Often the information on this is vague.
data manipulation
Data update frequency: How often is the oracle data updated? The market changes quickly.
Data Latency: What is the delay between the data point being measured and its incorporation into the data stream?
License Tracking: Is license information available on the underlying raw data? (e.g. exchange price data)
Gas Model: Who pays for the gas to keep the oracle running?
While there are many more factors to consider, the above are good directions to follow when choosing an oracle for your project. The ecology of the oracle machine deserves our continued attention, because with the rise of DeFi applications, the oracle machine will receive more scrutiny. After all, these DeFi applications require accurate and reliable data. Otherwise, people may lose a lot.
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