What Is Chainlink?
A Step-by-Step Guide to the 'Decentralized Oracle'
By: Rahul Nambiampurath • Loading...Beginners
For blockchains to provide a secure and immutable record — a public ledger — they have to be self-contained. Otherwise, outsiders could compromise it and hurt the value of the digital assets they support. This isolation prevents blockchains from being flexible.
Chainlink aims to solve this problem. It’s a decentralized oracle network that feeds off-chain data, such as asset prices, to on-chain smart contracts. As a result, Chainlink improves the functionality of dApps.
Chainlink (LINK) Origin and Purpose
Sergey Nazarov started the Chainlink project in 2014, one year before Ethereum launched. Although Nazarov has a bachelor’s degree in Philosophy and Management from New York University, he soon pursued his passion for entrepreneurship. He used Bitcoin mining to pay rent in the early 2010s.
He soon expanded his focus to smart contracts, describing their importance as “[they] enable a parallel, technically enforced legal system.” Nazarov and Steve Ellis founded the blockchain startup SmartContract in 2014.
In June 2017, SmartContract launched its premium product — Chainlink network. It came online on May 30, 2019, with LINK as the ERC-20 token hosted on the Ethereum blockchain.
Chainlink addresses the problem of smart contracts interacting with external data. On their own, smart contracts auto-execute agreements when conditions are met.
Nonetheless, some agreements need external data for conditions to be verified as fulfilled. This is where the Chainlink network steps in as an intermediate layer between blockchains and the off-chain world.
The Chainlink team raised $32M through Initial Coin Offering (ICO) in September 2017, by selling 290M LINK tokens at $0.11 each.
What Problem Does Chainlink Address?
To understand what Chainlink is all about, the first piece of the puzzle to grasp is smart contracts. Blockchain’s data blocks store smart contracts to power decentralized applications — dApps. For instance, a lending dApp like Aave uses smart contracts to:
- Tell how much funds were deposited as collateral
- Tell what is the interest rate for that particular crypto asset
- Issue a loan based on those data points
- Track the market price of the collateral, so it can be liquidated if it goes under a certain level
No intermediaries, just self-executing code to provide this ancient lending service. It is important to note that smart contracts are immutable precisely because they are hosted on a blockchain.
On the one hand, immutability provides confidence that smart contract conditions cannot be tampered with. On the other hand, smart contracts are confined only to data that is found on the blockchain. Or are they?
To tap into conditions that exist outside the blockchain network, a data conversion needs to happen, one from off-chain to on-chain data.
How Does Chainlink Network Function?
To execute conversion from off-chain to on-chain data, Chainlink uses oracles. They are best understood as intermediary software that formats real-world data into language understandable by on-chain smart contracts. This process is done bi-directionally.
But how can an oracle be trusted to secure real-world data as valid? The same way blockchain networks themselves establish trust — through decentralization. This way, there is a redundancy if the oracle is faulty or malicious.
Because a decentralized oracle network validates off-chain data, the on-chain smart contracts dependent on that data become trustworthy as well. How does this process work exactly?
Chainlink Conversion and Validation Pathway
There are multiple steps through which external data must go through to become trustworthy. The first step is when a smart contract requests off-chain data. This is the Requesting Contract.
The Requesting Contract then triggers a “request event” on the Chainlink network. In turn, Chainlink generates another smart contract called Service Level Agreement (SLA) Contract.
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In the next step, the SLA Contract creates three extra smart contracts:
- Chainlink Reputation Contract – checks if the oracle provider has sufficient reputation. This is done by verifying its performance history, by which less reliable oracle nodes are discarded.
- Chainlink Order-Matching Contract – as its name implies, it conveys Request Contract to Chainlink oracle nodes. In turn, oracle nodes bid for the request until the right match is made.
- Chainlink Aggregating Contract.- compiles the data from chosen oracle nodes and validates them as the final result to be injected into an on-chain smart contract.
Within these three smart contracts, Chainlink validates data as reliable. Chainlink Core software uses Request Contract data to format the request from on-chain language to off-chain language, applicable to the real-world source. In this new format, the request is routed to an API (application programming interface) that is in charge of collecting data.
With the data collection done, it is reformatted back to on-chain via the Chainlink Core software. Then, it is sent to the Chainlink Aggregating Contract. As noted, it compiles data, but it can reconcile them from multiple API sources.
In other words, if seven oracle nodes deliver a commodity price, such as gold, from five sources with one answer, but deliver another answer from two sources, then those two nodes are discarded. For extra reliability measures, the Chainlink Aggregating Contract can repeat this procedure multiple times for multiple data sources.
Chainlink (LINK) Tokenomics
LINK tokens serve as an oracle node monetization mechanism. When a Requesting Contract is issued, LINK token holders pay Chainlink nodes for their data validation. Each node operator can set their own market price, depending on the data that needs to be validated.
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Likewise, LINK token holders use their coins as their stake in the network. This way, Oracle node operators showcase their commitment to provide valid data. In April 2021, Chainlink 2.0 whitepaper introduced Explicit Staking. With this incentive system, Chainlink node operators lock up their LINK stash as a collateral.
In an event, their nodes are repeatedly deemed as unreliable or malicious, the collateral is slashed. Moreover, Chainlink’s Explicit staking introduced a super-linear staking economic model. This means that potentially bribed LINK holders have to have a stake larger than the combined LINK deposits of all oracle nodes.
Chainlink’s Explicit Staking. Source: Chainlink
Overall, this creates another layer of security to ensure on-chain smart contracts receive valid off-chain data.
As of September 2022, there are nearly 50% of LINK tokens in circulating supply, out of a maximum 1B. In May 2021, LINK reached its price peak at $52.88. Out of permanently limited 1B LINK tokens, 35% goes to oracle node validators, 35% were sold during ICO, and the rest go to the development team.
Chainlink Use Cases
Since its launch, up to September 2022, Chainlink has been used in validating $20B worth of smart contract funds, running over 1B data points and connecting to over 1,000 dApps. More notable dApps that use Chainlink oracle network are the following:
- Polychain Monsters: Using Chainlink’s VRF (Verifiable Random Function), it enables the blockchain game to fairly and randomly distribute NFTs.
- Aave: one of the largest lending services that need accurate asset prices.
- Synthetix: a derivatives trading platform that uses Chainlink to tokenize real-world asset prices (fiat currencies, commodities, etc.).
- Otonomi: blockchain-based insurance to gauge shipping delay insurance, within the marine and cargo industry.
- Liquity: another lending protocol that needs market price feeds for loans, collaterals, and its LUSD stablecoin.
- Ether Cards: a blockchain platform for gamifying discounts, rewards, and monetizing community engagement. It uses Chainlink’s VRF as its fair randomness generator to deliver NFT rewards.
Moreover, even centralized organizations tapped into Chainlink to verify data. Some of them are Associated Press, FlightStats, AccuWeather, Trader Joe, and FedEx. While Chainlink has some competitors, such as WinkLlink (WIN), Band Protocol (BAND), or Uma (UMA), LINK is by far the most used oracle network with at least 18 times larger market cap than the alternatives.
Additionally, Chainlink is not only used on Ethereum but on lightning-fast blockchains like Solana, Polygon, or Avalanche.
This series article is intended for general guidance and information purposes only for beginners participating in cryptocurrencies and DeFi. The contents of this article are not to be construed as legal, business, investment, or tax advice. You should consult with your advisors for all legal, business, investment, and tax implications and advice. The Defiant is not responsible for any lost funds. Please use your best judgment and practice due diligence before interacting with smart contracts.
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