For decentralized finance to work properly, it sometimes needs data that lies outside the blockchain.
This is where decentralized oracles come into play.
What they are and what they are for
Decentralized oracles are the gateways that connect Smart contracts, i.e. the blockchain code, to the real world. They provide access to real-world data in a secure way.
We must keep in mind that Smart contracts only have access to blockchain data, therefore, when a Smart contract needs data external to the blockchain to execute a function, it needs a reliable source to provide this data.
Oracles are nothing more than intermediaries, for example, they report the price of an asset that an entity such as a broker has reported at a particular point in time. They do not create the data, they collect it and make it available to the Smart contract.
Why they are necessary
The problems with using data external to the blockchain for Smart contracts to execute functions within the blockchain are twofold.
One is that they do not have access to that data and the other is that the data is not correct.
We must remember that in the blockchain transactions are irreversible, so if a Smart contract uses a real-world data that is incorrect, it may execute a function with no way back. This can cost one or more people a lot of money, so it is a major problem.
The use of decentralized oracles in insurers is very common in DeFi. In these companies, decentralized oracles are essential to verify that a certain event has occurred during claims.
Decentralized oracles solve both problems.
Centralized Oracles VS Decentralized Oracles
The first problem described can be solved by a centralized oracle.
This is owned by an entity which, in turn, is the sole source of oracle data. Thus, whether the Smart contract provides the correct results depends entirely on the information provided by this entity because it is the only one providing data to the oracle.
However, centralized oracles do not always solve the second problem, which is that the information is correct.
By relying on a single source of information, if this source fails, the oracle will not do its job, leading to serious consequences.
This can occur because the company providing the information has not collected the correct data or because this company acts negligently to benefit from the delivery of incorrect information.
This drawback is not present in decentralized oracles, which do manage to solve the problem of information veracity.
To begin with, a decentralized oracle obtains information from many different sources, decreasing the risk of incorrect information.
They also use cryptographic techniques to secure the transmission and verification of the information.
Finally, a decentralized oracle is not owned by a single entity. The ownership of the decentralized oracle is shared among the different agents involved in the operations of the oracle.
These are the companies or individuals who provide data to the oracle, the developers who create and maintain the oracle infrastructure, and shareholders of the company that created the oracle.
All these factors make decentralized oracles the best choice for feeding Smart contracts with real-world information and therefore the most widely used.
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