Author: OKX Ventures

The content of this article is provided by OKX Ventures researcher Sally Gu and does not constitute any investment advice. Please indicate the source when quoting, and for reprints, please contact the OKX Ventures team.

Introduction

With Vitalik recently mentioning the issue of ultimate oracles in his article, "oracles" have once again come into the spotlight of the crypto community. Currently, oracles have irreplaceable value in various fields and sectors such as insurance, finance, random prediction, and the Internet of Things. OKX Ventures' core view is that as long as off-chain data holds value, middleware like oracles will continue to play a key role in the narrative of Web3. Specifically, this can be broken down into the following aspects:

• In the context of the continuously evolving Web3 ecosystem, it is foreseeable that the increase in dapps and platforms will drive the demand for data sources and APIs accessed through oracles. In the future, dapps, especially DeFi exchanges, are likely to integrate more than one oracle (usually one as the primary data source and 1-2 as cross-validation backups) to obtain off-chain metadata, thereby avoiding unbearable losses to the protocol caused by delays or attacks on a single oracle (similar to incidents involving protocols like Venus).

• In terms of investment opportunities, although it is currently difficult to see who will break Chainlink's monopoly in the traditional DeFi oracle direction, there may still be competitive space for a second player in the remaining 10% of the market. Additionally, in niche areas, oracles in sectors such as L2, credit, NFTs, and DIDs have seen noteworthy innovative protocols and narratives emerging.

• Based on experiences from DEX and L1, and considering the incremental market demand as well as the emerging scenarios of L2/ZK and niche markets, it is unlikely that the oracle track will be monopolized by a single winner in the long run. There is still greater development potential and market space worth exploring, such as off-chain computing scenarios, pricing of non-standard on-chain assets like NFTs, and the deep integration of AI/ML.

In the following sections, we will provide an in-depth explanation of the concept, classification, application scenarios, and investment opportunities of oracles.

Event Background

According to Vitalik's recent article, he believes that a more effective trust mechanism for oracle protocols will emerge in the future. He mentioned two of his proposed solutions:

• Price Oracles: One is a decentralized oracle based on incomplete cryptoeconomics, and the other is an oracle based on validator voting.

• The latter primarily relies on emergency recovery strategies rather than resorting to L1 consensus for recovery. For example, price predictors depend on the trust assumption that voting participants may be bribed or corrupted, allowing users to receive attack warnings in advance and exit any systems relying on that oracle. Such oracles can deliberately delay rewards for a long time, so if the protocol fails, participants will not receive rewards.

• The proposal for price oracles is mainly based on the previously proposed schellingcoin/point mechanism, envisioning a reverse prisoner's dilemma game theory.

• The core idea is still to maintain the simplicity of the chain and avoid a hard fork of the chain caused by the failure of a single oracle.

• More complex truth oracles: used to report more subjective facts than prices.

• Similar to a decentralized court system built on incomplete cryptoeconomic DAOs.

• The idea of the Rocket Pool Oracle DAO composed of nodes should also align with Ethereum's expectations for oracle development.

• However, based on Vitalik's thoughts, he seems to prefer the first voting validator scheme based on complex game theory.

Track Data

Observing the overall oracle track data, Chainlink still holds a dominant position in the market. In the entire DeFi sector, oracles, as core middleware, have not received much attention. This is partly because most protocol tokens lack practical use cases, and partly because ordinary users in the market lack awareness and motivation to learn.

• However, it is worth noting that the token prices of the lower-ranked projects in the track, such as Band and UMA, have historically performed well.

• Additionally, protocols like Gelato that provide automation, cross-chain, and off-chain computing services have good fundamentals, and as teams gradually begin to enhance token utility, there is expected to be significant potential for growth.

• With more developers joining in the next cycle and the emergence of dapps, the demand for oracle data sources and APIs is unlikely to shrink. A large amount of untapped market increment could drive the sector to take off.

In summary, we believe that oracles, especially vertical oracle categories in niche tracks, can still be regarded as a worthy investment direction in the medium to long term.

Interpreting Oracles

1.1 Concept

Oracles are generally considered to be the bridge connecting on-chain and off-chain data. In simple terms, an oracle is a middleware that provides trustworthy off-chain data services for blockchain projects.

The main reason we need oracles is that the trust generated by the current blockchain itself is still insufficient to support all the needs of upper-layer applications, so oracles are needed to inject more trust:

• Currently, the volume of off-chain and on-chain data remains unequal. Compared to the rich data types and large volumes of the off-chain real world, the volume of data in the on-chain world is far from sufficient to support independent development away from off-chain. Most protocols would struggle to survive without integrating oracles.

• This is why many people say that oracles are a ++"necessary evil"++ for blockchains. ++One day, when the richness of on-chain data surpasses that of off-chain and becomes sufficiently thick, we may no longer need to rely on oracles or similar relay agents. This is also the fundamental reason why many DEX and DeFi protocols are very persistent in oracle-less on-chain native designs.++

Blockchains are closed systems that cannot directly connect to the internet, and smart contracts cannot directly retrieve deterministic information from the internet and the real world, including stock prices, exchange rates, and the final results of presidential elections. Moreover, due to the consensus mechanism, they require trustworthy third parties to verify the data. Therefore, oracles play more of a broker role in facilitating trust between on-chain and off-chain.

It is important to point out that the key problem that oracles solve is not how to obtain information from the real world (in fact, anyone, including you and me, can upload off-chain data to the on-chain), but ++how to help the blockchain trust information from the real world++ (even if you and I upload off-chain data to the on-chain, it is useless; no one will believe it, and thus no one will adopt it, which also involves the issue of honest nodes).

Trust is generated through communication, not just connection. Therefore, the intrinsic value of an oracle depends on its ability to open communication channels between on-chain and off-chain, which is to inject trust into off-chain data through forwarding, verifying, and filtering information. Thus, the key point in judging the quality of an oracle is to understand "to what extent it is trustworthy."

1.2 Classification

Based on form, we can classify oracles into software oracles and hardware oracles:

• Software Oracles: Provide services like APIs/SDKs to help protocols access and transmit data from third-party servers, such as commodity prices, weather indices, flight numbers, etc.

• Hardware Oracles: Hardware oracles are widely used in IoT, commonly seen in electronic sensors and data collectors.

Based on data sources, they can be divided into centralized oracles and decentralized oracles:

• Centralized Oracles: Typically integrate data from a single trusted third party, such as government departments, official institutions, reputable companies, etc. Its advantage is that it can separate data from untrusted operating systems on local devices, preventing data tampering and loss. The disadvantage is that centralized data brings the risk of a single point of failure.

• Decentralized Oracles: Decentralized oracles refer to oracles with a distributed consensus mechanism, also known as consensus oracles. They obtain data from multiple rather than a single external source, making them more reliable and trustless.

Centralized vs. Decentralized

• Centralized oracles have advantages in efficiency and feasibility. Decentralized oracles, due to their discrete multi-node and cross-referencing processes, are more trustworthy and secure.

• When efficiency is not the primary goal, centralized solutions are not the most desirable. Clearly, the information provided by a single node is likely to be biased and dogmatic; in such cases, authority comes from despotism rather than credibility.

• Due to the need and concerns for trust risk management, most DeFi applications directly adopt third-party decentralized oracles like Chainlink rather than independently creating a simple centralized oracle or running nodes to transport off-chain data to the chain (again emphasizing that even if projects or individuals upload data to the chain themselves, they cannot gain community trust).

1.3 Application Scenarios

In 2021, Chainlink 2.0's white paper first introduced the concept of DON (Decentralized Oracle Network). A DON is a network maintained by a group of Chainlink nodes that allows Chainlink to provide external data to the blockchain through trustless off-chain computation. To achieve this vision, Chainlink launched a series of products and services such as VRF, Keepers, CCIP, further opening up the application scenarios for oracles in Web3. In the following diagram, we list various application cases of oracles in different scenarios such as DeFi, NFTs, GameFi, Social, DAOs, and cross-chain for reference:

1.4 Track Map

We believe that oracles can be simply classified into three dimensions:

These are based on specific functions, data sources, and data processing methods.

1. Based on ++specific functions++, in addition to common DeFi oracles, we list three common types: credit oracles, NFT oracles, and identity (DID) oracles.

2. Based on ++data sources++, they can be divided into three types: first-party oracles, third-party oracles, and multi-party oracles.

3. According to ++data processing methods++, they can be divided into five types: game theory-based oracles, reputation-based oracles, staking-based oracles, cryptographic oracles, and aggregation-based oracles.

Investment Opportunity Expectations

2.1 Views

A. In the traditional DeFi direction dominated by data feeding oracles, it is currently difficult to see who will break Chainlink's monopoly (with a market share of 80-90%). However, there may still be competitive space for a second player in the remaining ++10% of the market++:

One is that this project has innovative consensus mechanisms, and Vitalik has provided two solutions that may lead to theoretically viable projects in the future:

• Game theory as the core, combined with PoS/PoW.

• DAO committees/decentralized court forms.

One is a significant improvement in functional cost-effectiveness, where feeding prices or generating random numbers is cheaper than Chainlink, such as Redstone and Ontropy, which claim their pricing can be 80-100 times cheaper than traditional solutions like Chainlink. Generally, only under the premise of significantly reducing calling costs will DeFi or gaming projects consider replacing original service providers like Chainlink for economic reasons.

B. In niche areas, oracles in sectors such as L2, credit, NFTs, and DIDs have potential opportunities:

L2 Oracles are mainly native solutions for op/zk ecosystems, with low latency and security being core concerns, while cheap pricing is relatively secondary.

• Consider Chainlink's expansion progress on non-EVM chains; if pricing on a certain chain is already monopolized by Chainlink, the difficulty of competition will greatly increase.

• L2 oracles should largely cater to the ++high-frequency trading++ demands of derivative exchanges (L2 can provide higher TPS support, thus enabling decentralized derivative trading on-chain), similar to oracle protocols like Pyth and Empiric that offer more refined pricing or more robust data integration processes (such as directly doing on-chain first-party data integration + verification, eliminating the need for off-chain nodes).

• If tokenomics is designed reasonably to include more utility (Chainlink's tokenomics design has been criticized for lacking utility, but later developments like LinkPool's liquidity staking + yield protocols have somewhat activated liquidity), we believe that typically, the token prices of oracle protocols can be expected to perform relatively steadily.

Credit oracles combined with on-chain credit expansion theory may ignite in the next cycle.

• The improvement and soundness of on-chain credit rating systems are prerequisites for building on-chain insurance and recovery mechanisms, thus playing an important role in the development and evolution of DeFi as a whole. In the previous track map, we have already provided several examples of credit oracles: CreDA\Cred Protocol\LedgerScore\Spectral\Credora: Infrastructure for Institutional Credit, etc.

• In this specific niche direction, we believe more attention should be paid to the differences in on-chain data verification and integration among similar products (such as coverage, cleansing ability, and accuracy of credit ratings). Additionally, if the team has a strong background in financial engineering or actuarial skills, it would be a good plus.

• At the same time, we also note that the entire process of integrating off-chain credit systems onto the chain may be more complex than expected:

• On one hand, it is difficult for a single project to directly link with a country's social credit system. A key question may be: can off-chain economic activities genuinely endorse on-chain credit capabilities? However, projects like Spectral Finance, which have strong business development capabilities and collaborate directly with major credit rating agencies in the U.S., may offer a good solution.

• On the other hand, integrating publicly available off-chain credit data onto the chain has a low barrier (theoretically, traditional internet cloud teams have the capability to develop and implement related functions).

NFT Oracles can be divided into two main approaches:

One is TWAP (Time-Weighted Average Price), and there are also those using moving averages.

• Currently, VWAP cannot be achieved due to insufficient trading volume. Considering the illiquid and non-homogeneous nature of NFTs, we also do not foresee the implementation of NFT VWAP in the short term.

• Traditional DeFi oracles like Chainlink and DIA have already provided TWAP pricing services for NFTs, and many will directly adopt Chainlink's TWAP solution.

• After communicating with relevant technical teams, we tend to believe that most current NFT TWAP pricing functions are still in the preliminary stage, and there is room for optimization in integration methods, but overall, this direction does not have great development prospects.

The other approach is to use AI/ML combined off-chain computing valuation pricing solutions, which we believe have relatively better prospects.

• There could be some horizontal integration later, transforming into a full-stack NFT data analysis + purchasing + evaluation application (a good potential scenario for activating liquidity and traffic entry for NFT spot trading).

• However, such solutions are difficult to gain trust in cooperation agreements due to their non-open-source algorithms (for example, Upshot and Banksea, despite achieving good results in financing, find it challenging to create revenue sources or issue tokens in the short term; profitability relies on other derivative businesses, such as wallet data analysis and market integration service fees).

• Open-source ML solutions like Nabu may offer a good transparent option, but their future profitability remains hard to predict. However, if similar protocols can transform into an open-source ML model DAO + token issuance, referencing the commercialization ideas of security tracks like Forta/Go+, theoretically, there is good potential for development.

DID Identity Oracles serve to aggregate user off-chain data onto the chain for identity verification and social graph mapping, which holds high value in the long term.

• Chainlink's CanDID (DECO) team attempts to create a decentralized on-chain identity infrastructure relying on highly optimized multi-party computation and zero-knowledge proof technology. Similar zkDID projects like LegalDAO and Intuition are also providing similar solutions through DAO committee-type identity verification services.

• However, most identity oracles we currently see are basically centralized with low barriers (although many plan to transition to decentralized forms in the future, their feasibility is hard to verify without actual implementation).

• It is also essential to focus on their verification processes (such as the quality of nodes and whether the verification is trustworthy) and storage methods.

2.2 Cases

Based on the investment views provided above, we have selected one case for simple analysis in each niche direction for reference.

In summary, OKX Ventures believes that with the continuous development of blockchain technology, oracles will continue to play an indispensable role in the crypto sector in the next cycle, and greater development potential and market space are still worth exploring, such as off-chain computing scenarios, pricing of non-standard on-chain assets like NFTs, and the deep integration of AI/ML. We will also keep a close eye on innovative protocols and investment opportunities in the oracle track.