A deep technical development, with potentially far-reaching, albeit not obvious repercussions. That’s how we could summarize today’s announcement by Chainlink, regarding the upgrade in its network.
Chainlink is the maker of the homonymous oracle service, which powers between 50% and 80% of DeFi applications, according to Chainlink CEO Sergey Nazarov. ZDNet caught up with Nazarov to discuss the upgrade, as well as blockchain applications, DeFi, data availability, and how they are all connected.
Ethereum, Smart contracts, Oracles, DeFi, and Data
DeFi stands for Decentralized Finance. In short, DeFi’s promise is to be able to cut out middlemen from all kinds of transactions. Similar to how 2017 was the year of ICOs, 2020 was the year of DeFi. Lots of growth, some of it warranted, although oftentimes the “decentralized” part was more of a euphemism, and governance remains a sore spot.
DeFi applications are built on the Ethereum blockchain, utilizing its smart contract capabilities. You can think of smart contracts as programs that execute exactly as they are set up by their creators on the Ethereum blockchain.
Smart contracts enhance Ethereum with the ability to execute tamper-proof code, in addition to storing tamper-proof data, turning it into a “world computer.”
Smart contracts promise to take execution of processes and agreements to the Ethereum global computer. There’s just one problem: Smart contracts can’t talk to the rest of the world. This is where oracles, and Chainlink, come in.
An oracle is a gateway between a blockchain and the real world. Oracles can get data off the blockchain and pass it on to smart contracts.
When Chainlink launched in 2019, it did so with three endorsed oracles, including its own. A lot of water has flowed under the bridge since. Nazarov claimed that the “Summer of DeFi” — the ongoing boom in total value locked in DeFi applications that started in July 2020 — strongly correlates with Chainlink making more data available at that time.
The reasoning is that many of these DeFi protocols largely rely on external data to work, and the availability of that data largely relies on Chainlink. Nazarov went on to add that between 50% and 80% of DeFi applications consume data from Chainlink, which makes an upgrade to its service quite important.
Why the need for an upgrade? Up until now, when Chainlink oracle nodes pull data from external sources, they have to bring it on-chain, and then aggregate it. When each oracle node has to bring data onto Ethereum, this incurs a lot of ETH gas costs for the oracle node operators.
Chainlink’s software is open source, and not all nodes are operated by Chainlink. Regardless, whoever operates a node, must consume ETH tokens to bring data on Ethereum and perform computations on it. This drastically limits the amount of data that nodes can handle, especially as the price of ETH goes up.
The solution that Chainlink introduces is so-called Off-Chain Reporting (OCR). What this means is that data storage and computation is no longer performed on the Ethereum blockchain, but in a different decentralized network. The key word here is decentralized.
Nazarov noted that security has been the top concern for Chainlink from Day One. That was the reason they started with an on-chain solution, and only moved to off-chain when they felt confident that what they have works, scales, and can be tamper-proof.
Nazarov mentioned that Chainlink’s OCR solution involved some top cryptographers such as Christian Cachin and Ari Juels. He also referred to Chainlink’s philosophy of gradual expansion: “The right way to build secure systems is to think on first principles, design a system that works for one use case very well. See it work in that use case pretty well, then take the learning from that and gradually expand it to other verticals, other applications that have the same security concerns.”
The one area that Chainlink is currently focusing on is DeFi, driven as Nazarov said by customer demand. Chainlink offers what it calls data feeds, “the largest collection of tamper-proof, on-chain price reference data available.”
Doing what blockchains don’t do
These feeds are sponsored by a number of third-party application developers. The reasoning behind that, as Nazarov explained, is that by doing so, application developers collectively ensure security. Nazarov said:
“It’s an economic model that allows users of the data feeds to share the cost of the data feed. Each additional sponsor puts in a fee that’s lower than the cost of the network that they’re using. But then their aggregate fees collectively pay for more security for all of them.
All of those fees go to the node operators. None of those fees go to us unless we’re a node operator. And on about 98% of the networks we’re not a node operator anymore at all.
Chainlink is a piece of software, a framework for people to compose oracle networks and to pay for those oracle networks in a way that creates more security as more users use this network. Because everybody needs that data.”
Chainlink claims OCR significantly improves the efficiency of how data is aggregated, reducing operating costs by up to 90% and enabling the Chainlink Network to accelerate the development of universally connected smart contracts both in DeFi markets and across various other industries.
The most immediate benefit to DeFi and its users will be a 10x increase in the amount of real-world data that can be made available to smart contract applications. Nazarov referred to decentralized insurance and blockchain-based gaming as the next areas in which he expects to see growth.
Nazarov also referred to OCR as a “general purpose off-chain trust minimization computation framework that does what blockchains don’t do.” The goal is to hit a sweet spot between blockchains, which are trustworthy but not very efficient, and centralized services, which are efficient but not very trustworthy.
That is quite ambitious. However, Nazarov was confident that the team is on the right path. “Our OCR white paper is going to be presented in computer science conferences — it’s not something we cooked up in a weekend,” he said.
As the OCR white paper is out now, it will certainly attract attention from domain experts. Chainlink’s oracle framework seems like a key piece of the puzzle in the growth of the blockchain application ecosystem.
If this general-purpose off-chain trust minimization computation framework that does what blockchains don’t do works as intended, it’s big news and a facilitator for new applications.