OKX Ventures: Rethinking Oracles, Seeing What Has Been Seen and What Has Not Been Seen.

Source: OKX Ventures

Introduction

With Vitalik recently mentioning the issue of the ultimate oracle in his article, "oracle" has once again entered the focus of attention in the cryptocurrency community. Currently, oracles have irreplaceable value in multiple fields and sectors such as insurance, finance, random prediction, and the Internet of Things. OKX Ventures' core belief is that as long as off-chain data still holds value, middleware such as oracles will continue to play a critical role in the narrative of Web3. Specifically, in the following aspects:

- Against the backdrop of the continuous development of the Web3 ecosystem, it is foreseeable that the increase in dapps and platforms will drive the expansion of the demand for calling data sources and APIs through oracles. In the future, dapps, especially defi exchanges, are likely to integrate more than one oracle (usually one as the main data source and 1-2 as cross-validation backups) to obtain off-chain metadata, thereby avoiding the protocol's unbearable losses caused by delays or attacks on a single oracle (similar to incidents in protocols such as Venus).

-In terms of investment opportunities, although traditional defi focuses on data feed price function as the main direction of oracle, it is difficult to see who will break the monopoly of chainlink in the short term. However, there may still be competition space for the second place in the remaining 10% or so of the market. In addition, there are innovative protocols and narratives worth noting in the segmented areas of oracle, such as L2, credit, NFT, DID and other directions.

- Based on the experience of DEX and L1, from the perspective of incremental market demand and the dimensions of L2/ZK and emerging scenarios, it is impossible for the oracle track to be monopolized by only one winner in the long run. There is still great potential for development and market space to be explored, such as off-chain computing scenarios, non-standard on-chain asset pricing such as NFT, and the deep integration of AI/ML.

In the following text, we will provide a comprehensive explanation of the concept, classification, application scenarios, and investment opportunities of oracle.

Event Background

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

-Price Oracle: One is a decentralized oracle of incomplete cryptoeconomics, and the other is a validator-voting-based oracle.

- The latter mainly relies on emergency recovery strategies rather than resorting to L1 consensus to recover. For example, price predictors rely on the trust assumption that voting participants may be corrupted by bribery, and users can receive attack warnings in advance and exit any system that relies on the oracle. Such oracles can intentionally delay rewards for a long time, so if the protocol fails, participants will not receive rewards.

- The proposal for the price oracle is mainly based on the previously proposed Schellingcoin mechanism, envisioning a reverse prisoner's dilemma-style game theory.

Its core idea is still to maintain the simplicity of the chain, avoiding a single oracle failure directly causing a hard fork of the chain.

More complex oracle: used to report facts that are more subjective than price.

Similar to a decentralized court system built on a DAO (Decentralized Autonomous Organization) that is not fully encrypted, as described in this article.

-Rocket Pool Oracle DAO The idea of forming a DAO with nodes should also align with Ethereum's expectations for the development of oracles.

- However, according to Vitalik's perspective, he seems to lean towards the first type of validator solution based on complex game theory.

Race Data

Observing the overall data of the oracle track, Chainlink still holds a dominant position in the market. As a core middleware in the entire defi track, oracles have not received much attention, partly due to the lack of practical use cases for most protocol tokens, and partly due to the lack of awareness and learning motivation among ordinary users in the market.

-However, it is worth noting that the coin prices of some of the lower-ranking projects in the reference track, such as Band and UMA, have also performed well historically.

- In addition, protocols such as Gelato that provide automation, cross-chain, and off-chain computing services have good fundamentals. As the team gradually begins to empower tokens and increase utility, there is also expected to be a lot of room for imagination.

-With the addition of more developers and the emergence of dapps in the next cycle, the demand for oracle calling data sources and APIs cannot reverse shrink. A large amount of untapped market potential may drive the sector to take off.

Overall, we believe that oracle, especially the vertical oracle category in segmented tracks, can still be considered as an investment direction worth paying attention to in the medium to long term.

Interpreting Oracle

1.1 Concept

Oracle is generally considered as a bridge that connects on-chain and off-chain data in the encryption industry. In short, Oracle is a middleware that provides trustworthy off-chain data services for blockchain projects.

The biggest reason we need oracles in the encryption industry is that the trust generated by the blockchain itself is not enough to support all the needs of upper-layer applications. Therefore, we need oracles to inject more trust:

-Currently, the amount of data off-chain and on-chain is still unequal. Compared to the rich data types and massive data volume of the off-chain real world, the amount of data on-chain is far from enough to support its complete independent development. Most protocols currently will have difficulty surviving without access to an oracle.

-This is also why many people say that oracles are a "necessary evil" for blockchain. When the richness of on-chain data surpasses that of off-chain data one day, and becomes thick enough, we will no longer need to rely on oracles or similar relay agents. This is also the fundamental reason why many DEX and DeFi protocols are so persistent in designing on-chain native solutions without oracles.

Blockchain is a closed system that cannot directly connect to the internet. Smart contracts cannot directly access deterministic information from the internet or the real world, such as stock prices, exchange rates, or the final results of presidential elections. Additionally, due to the consensus mechanism, trusted third parties are needed to verify data. Therefore, oracle plays a role more like a broker that matches trust between on-chain and off-chain.

It is worth noting that the key problem solved by the oracle here is not how to obtain information from the real world (in fact, anyone, including you and me, can upload off-chain data to the chain), but how to help the blockchain trust information from the real world (even if you and I upload off-chain data to the chain, it will be useless if no one believes it, which also involves the issue of honest nodes).

The generation of trust relies on communication, not just connection. Therefore, the intrinsic value of an oracle depends on its ability to bridge the communication gap between on-chain and off-chain data, which is achieved through forwarding, verifying, and filtering information to inject trust into data from the real world. Therefore, the key to determining the quality of an oracle lies in understanding how much it is "worthy of trust".

1.2 Classification

According to the form, we can divide the oracle into software oracle and hardware oracle based on the form.

-Oracle: Provides API/SDK services to help protocols access and transmit third-party server data, such as commodity prices, weather indices, flight numbers, etc.

-Hardware Oracle: Hardware Oracle is widely used in IoT, commonly seen in electronic sensors and data collectors.

According to the data source, it can be divided into centralized oracle and decentralized oracle.

-Centralized Oracle: Usually only integrates a single trusted third party such as government departments, official agencies, reputable companies, etc. to provide data. Its advantage is that it can separate data from untrusted operating systems on local devices, preventing data tampering and loss. The disadvantage is that the centralized data brings the risk of single point of failure.

-Decentralized Oracle: Decentralized Oracle refers to an oracle with a distributed consensus mechanism, also known as a consensus oracle. It obtains data from multiple external sources instead of a single one, making it more reliable and trustless.

Centralized vs Decentralized

Centralized oracles have advantages such as efficiency and feasibility. However, decentralized oracles are more trustworthy and secure due to their discrete multi-node and cross-reference processes.

When efficiency is not the primary goal, centralized solutions are not the most desirable. Obviously, the information provided by a single node is likely to be biased and arbitrary. In this case, authority comes from dictatorship rather than credibility.

Due to the requirements and concerns of trust risk management, most DeFi applications basically adopt third-party decentralized oracles such as Chainlink instead of independently developing a simple centralized oracle or running nodes to transfer data to the chain (once again emphasizing that even if the project party or individual transfers data to the chain themselves, they cannot gain community trust).

1.3 Application Scenarios

 1.4 Track Map

We believe that three dimensions can be used to classify oracle in a simple way:

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

According to specific functions, in addition to the common defi oracle, three common types are listed here: credit oracle, NFT oracle, and identity (DID) oracle.

According to the data source, there are three types of oracles: first-party oracles, third-party oracles, and multi-party oracles.

According to the data processing method, it can be divided into five types: game theory-based oracle, reputation-based oracle, pledge-based oracle, cryptography-based oracle, and aggregation-based oracle.

Investment Opportunity Expectations

2.1 Viewpoint

A. Traditional defi focuses on the data feeding price function as the main direction of the oracle. In the short term, it is difficult to see who will break the monopoly of Chainlink (market share of 80-90%). However, there may still be competition for the second place in the remaining 10% market:

One is that this project has consensus mechanism innovation. Vitalik has given two proposals and there may be projects in the future that will have theoretical implementation.

With game theory as the core, combined with PoS/PoW

One is a significant improvement in cost-effectiveness, where feed price or random number generation is cheaper than Chainlink, such as Redstone, Ontropy, etc., claiming that their feed price can be 80-100 times cheaper than traditional solutions like Chainlink. Generally speaking, only when the cost of calling is significantly reduced, will defi or gaming project parties consider using it to replace the original service providers such as Chainlink for economic reasons.

B. Opportunities exist in several directions such as L2, credit, NFT, DID, etc. in the sub-fields of oracles:

-L2 Oracle is mainly the native solution for the op/zk ecosystems. Low latency and security should be the core concerns, while cheap price feeds are relatively secondary.

- It is necessary to consider the expansion progress of Chainlink on various non-EVM chains. If the price feeds on a certain chain are mostly monopolized by Chainlink, the competition difficulty will be greatly increased.

-L2 oracle is largely intended to meet the high-frequency trading demands of derivative exchanges (L2 can provide higher TPS support, thus supporting on-chain decentralized derivative trading), similar to oracle protocols such as Pyth and Empiric that provide more precise price feeds or more robust data integration processes (such as direct on-chain first-party data integration and verification, eliminating the need for off-chain nodes).

-If the tokenomics design is reasonable and more utility is added (Chainlink's tokenomics design was once criticized for lack of utility, but later liquidity staking + yield farming protocols like LinkPool appeared, which to some extent activated liquidity), we believe that the coin price of most oracle protocols can expect a relatively stable performance.

The credit oracle combined with on-chain credit expansion theory is likely to explode in the next cycle.

-The improvement and perfection of the on-chain credit rating system is a prerequisite for building on-chain insurance and claims mechanisms, and therefore plays an important role in the development and evolution of the entire DeFi industry. In the previous track map, we have provided several examples of credit oracles:  CreDA\Cred Protocol\LedgerScore\Spectral\Credora: Infrastructure for Institutional Credit, etc.

- As far as this specific subdivision is concerned, we believe that more attention should be paid to the differences in on-chain data validation and integration among similar products (such as on-chain data coverage, cleaning ability, and credit rating accuracy). In addition, having a strong background in financial engineering or actuarial skills would be a plus for the team.

- At the same time, we also noticed that the entire project of linking the off-chain credit system to the chain will be more complex than expected:

- On the one hand, it may be difficult for individual projects to directly link with a country's social credit system. A key issue may be whether off-chain economic activities can truly endorse on-chain credit capabilities. However, for projects like Spectral Finance with strong BD capabilities, partnering directly with large US credit rating agencies may be a good solution.

-On the other hand, integrating the publicly available credit data from off-chain onto the blockchain itself does not have a high barrier to entry (in theory, cloud teams from traditional internet companies have the ability to develop and implement relevant functions).

NFT oracles are mainly divided into two approaches:

One is TWAP (Time-Weighted Average Price), and of course, there are also those that use moving averages.

Currently, it is not possible to implement vwap due to insufficient trading volume. Considering the illiquidity and non-fungible nature of NFTs, we are unlikely to foresee the implementation of NFT vwap in the short term.

Chainlink, DIA, and several traditional DeFi oracle providers currently offer NFT TWAP price feed services, with many opting for Chainlink's TWAP solution.

After communicating with relevant technical teams, we tend to believe that most NFT twap price feed functions are still in the preliminary stage, and there is room for optimization in the integration method. However, overall, the development prospects of this direction are not significant.

One approach is to use an off-chain valuation and pricing scheme that combines AI/ML, which we believe has more potential.

You can perform some horizontal integration in the later stage and transform into a full-stack NFT data analysis, purchase, and evaluation application (NFT spot traffic entry and liquidity activation plan), which is a good potential scenario.

However, such solutions are essentially black boxes due to the closed-source algorithms, making it difficult to gain trust in cooperation agreements (such as upshot, banksea). Although they have achieved good results in financing, the projects are difficult to generate revenue or issue coins in a short period of time, and profits rely on other derivative businesses such as wallet data analysis and market integration services that charge transaction fees.

Nabu, a similar open-source ML platform, may be a good transparent solution, but its future profitability is still difficult to predict. However, if similar protocols can transform into an open-source ML model DAO+token issuance, following the commercialization strategy of Forta/Go+ in the security field, theoretically, there is also good potential for development.

DID Identity Oracle is a protocol service that collects user off-chain data and uploads it to the chain for identity verification and social graph drawing. This niche field has long-term high value.

The CanDID (DECO) team under Chainlink is trying to build a decentralized on-chain identity infrastructure with highly optimized multi-party computation and zero-knowledge proof technology. Similar solutions are also provided by zkDID projects such as legalDAO and Intuition, which design DAO committee-type identity verification services.

However, currently most of the identity oracle systems that we see are centralized, with low barriers to entry (although most plan to transition to a decentralized form in the future, it is difficult to verify their feasibility without actual implementation).

At the same time, it is necessary to pay close attention to its verification process (such as the quality of nodes and whether the verification is trustworthy) and what is used for storage and how it is implemented.

2.2 Case Study

According to the investment perspective given in the previous text, we have selected a case for simple analysis in each subdivision direction for reference.

Overall, OKX Ventures believes that as blockchain technology continues to develop, oracle will still play an indispensable role in the encryption track in the next cycle. There is still great potential for development and market space to be explored, such as off-chain computing scenarios, non-standard chain-based asset pricing such as NFT, and the deep integration of AI/ML. We will also keep a close eye on innovative protocols and investment opportunities in the oracle track.

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