For blockchains to provide a secure and immutable record, a public ledger, they must be independent. Otherwise, outsiders could compromise it and damage the value of the digital assets they support. This isolation prevents blockchains from being flexible.
Chainlink aims to solve this problem. It is 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, a year before the launch of Ethereum. Although Nazarov has a BA in Philosophy and Management from New York University, he soon pursued his passion for entrepreneurship. He used Bitcoin mining pay the rent in the early 2010s.
He soon expanded his focus to smart contracts, describing their importance as “[they] allow a parallel legal system, technically applied”. Nazarov and Steve Ellis founded blockchain startup SmartContract in 2014.
In June 2017, SmartContract launched its premium product – the Chainlink network. It went online on May 30, 2019, with LINK as the ERC-20 token hosted on the Ethereum blockchain.
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Chainlink addresses the issue of smart contracts interacting with external data. On their own, smart contracts automatically execute agreements when conditions are met.
However, some agreements require external data for conditions to be verified as met. This is where the Chainlink network comes in as a middle layer between the blockchains and the off-chain world.
The Chainlink team raised $32 million through an initial coin offering (ICO) in September 2017, selling 290 million 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 understand is smart contracts. Blockchain data blocks store smart contracts to power decentralized applications – dApps. For example, a lending dApp like Aave uses smart contracts to:
- Indicate how much funds were deposited as collateral
- Indicate 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 falls below a certain level
No middleman, 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 the terms of the smart contract cannot be altered. On the other hand, smart contracts are limited only to the data found on the blockchain. Or are?
To take advantage of conditions that exist outside of the blockchain network, a data conversion, from off-chain data to on-chain data, must be performed.
How does the Chainlink network work?
To execute the conversion from off-chain data to on-chain data, Chainlink uses oracles. They are best understood as middleware that formats real-world data into a language understandable for on-chain smart contracts. This process is done bidirectionally.
But how can an oracle be trusted to ensure that real-world data is valid? In the same way that blockchain networks themselves establish trust, through decentralization. In this way, there is a redundancy if the oracle is faulty or malicious.
Because a decentralized Oracle network validates off-chain data, on-chain smart contracts that depend on that data also become trusted. How does this process work exactly?
Chainlink conversion and validation pathway
There are several steps that external data must go through to become trustworthy. The first step is when a smart contract requests data off-chain. This is the Applicant Contract.
The solicitation contract triggers a “request event” on the Chainlink network. In turn, Chainlink generates another smart contract called a Service Level Agreement (SLA) Contract.
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In the next step, the SLA contract creates three additional smart contracts:
- Chainlink Reputation Contract – Check if the Oracle provider has enough reputation. This is done by checking their performance history, whereby less reliable Oracle nodes are ruled out.
- Chainlink Order Matching Contract – as its name implies, it transmits the contract request to Chainlink’s oracle nodes. In turn, the Oracle nodes bid on the request until the correct match is achieved.
- Chainlink Aggregation Contract.- Compiles the data from the chosen Oracle nodes and validates it as the final result to be injected into an on-chain smart contract.
Within these three smart contracts, Chainlink validates the data as trustworthy. The Chainlink Core software uses the request contract data to format the request from the on-chain language to the 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 responsible for collecting the data.
After the data collection is complete, it is reformatted on-chain through the Chainlink Core software. It is then sent to the Chainlink aggregation contract. As noted, it compiles data, but you can reconcile it from multiple API sources.
In other words, if seven Oracle nodes return the price of a commodity, such as gold, from five sources with one response, but return another response from two sources, then those two nodes are discarded. For additional measures of reliability, Chainlink’s aggregate contract can repeat this procedure multiple times for multiple data sources.
Chain Link Tokenomics (LINK)
LINK tokens serve as a monetization mechanism for Oracle nodes. When an application contract is issued, LINK token holders pay Chainlink nodes for validation of their data. Each node operator can set its own market price, based on the data it needs to validate.
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Similarly, LINK token holders use their coins as their stake in the network. In this way, Oracle node operators show their commitment to providing valid data. In April 2021, Chainlink 2.0 White Paper introduced explicit staking. With this incentive system, Chainlink node operators keep their LINK reserve as collateral.
In an event your nodes are repeatedly deemed unreliable or malicious, the warranty is reduced. Additionally, Chainlink’s explicit staking introduced a super-linear staking economic model. This means that potentially bribed LINK holders must hold a larger stake than the combined LINK deposits of all Oracle nodes.
In general, this creates another layer of security to ensure that on-chain smart contracts receive valid off-chain data.
As of September 2022, there are almost 50% of LINK tokens in circulation, out of a maximum of 1B. In May 2021, LINK reached its maximum price at $52.88. Of the permanently capped 1B LINK tokens, 35% goes to Oracle Node Validators, 35% was sold during the ICO, and the rest goes to the development team.
Chainlink Use Cases
Since its launch, as of September 2022, Chainlink has been used to validate $20 billion in smart contract funds, run over 1 billion data points, and connect to over 1,000 dApps. The most notable dApps using the Chainlink Oracle Network are the following:
- polychain monsters: Using Chainlink’s VRF (verifiable random function), it enables the blockchain game to distribute NFTs fairly and randomly.
- Ave: one of the largest loan services that need accurate asset pricing.
- Synthesis: a derivatives trading platform that uses Chainlink to tokenize the prices of real-world assets (fiat currencies, commodities, etc.).
- Otonomi: Blockchain-based insurance to measure shipping delay insurance, within the maritime and cargo industry.
- Liquidity– Another lending protocol that needs market price sources for loans, collateral, and its LUSD stablecoin.
- Aether Cards: a blockchain platform to gamify discounts, rewards and monetize community participation. It uses Chainlink’s VRF as its fair randomness generator to deliver NFT rewards.
Furthermore, even centralized organizations turned to Chainlink to verify the 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 widely used Oracle network with a market capitalization at least 18 times larger than the alternatives.
Furthermore, Chainlink is not only used on Ethereum, but also on ultra-fast blockchains like Solana, Polygon, or Avalanche.
This article in the series is intended for general guidance and information purposes only for beginners involved in cryptocurrencies and DeFi. The content of this article should not be construed as legal, business, investment or tax advice. You should consult with your advisors regarding all legal, business, investment and tax advice and implications. The Defiant is not responsible for lost funds. Please use your best judgment and practice due diligence before interacting with smart contracts.