Title: 《Web3 needs to be decentralized. Are oracles helping?》

Author: UMA Project

Compiled by: ChainCatcher

Tl;dr: The oracle design space features many innovative projects, but some have made significant trade-offs. If Web3 is to succeed, it will need trustless oracles to stay true to the decentralized spirit of cryptocurrency.

Key Points:

Oracles play a crucial role in today's DeFi and the broader crypto ecosystem, and as more data moves on-chain, they should see wider usage in the future.

While oracles help power Web3, they often suffer from reliance on centralized points of failure. UMA's optimistic oracle is one of the only decentralized solutions available for verifying any type of data in Web3.

As Web3 has grown, oracles have taken on an increasingly important role in the ecosystem. Oracles provide data for smart contracts, enabling a wide variety of use cases. Today, they have become a pillar of Web3 as they help bring real-world data on-chain, but smart contracts cannot verify whether the data is up-to-date and reliable. The oracle problem remains one of the biggest challenges facing cryptocurrency, but the ecosystem has begun to rely on various solutions.

With the emergence of new Web3 innovations, the landscape of oracles is changing. Today, the oracle space has a market cap of around $5 billion, but the ecosystem it supports is an order of magnitude larger. Undoubtedly, the biggest use case for oracles today is in DeFi, which was valued at nearly $200 billion at its peak. But as more data moves on-chain, we can expect to see new and larger oracle use cases emerge.

The oracle space has several projects that take different approaches to powering Web3. However, due to the difficulty of providing off-chain data to blockchains, some oracles have made trade-offs on core crypto principles like decentralization. This feature explores the oracle space and explains why Web3 needs to adopt trustless solutions to realize its potential.

The Oracle Bull Case

DeFi is currently the reason for Web3's existence, and oracles are the cornerstone of the DeFi ecosystem. They enable activities like lending by providing information about asset prices. Without oracles supplying price data, DeFi projects would be unable to calculate loan collateral or maintain stablecoin pegs, leading to the collapse of the ecosystem.

Although oracles can be used to verify any type of data, most solutions focus on providing price information for assets. Chainlink, the most popular price feed oracle solution in DeFi, powers many of the most commonly used applications in the space and commands about 75% of the market cap in the oracle domain.

"The true potential of oracles is greater than just DeFi."

Oracles are useful for many other functions. They can provide floor price data for NFT collectibles, supporting use cases like NFT index tokens and derivatives. Even sports brands are now using oracles to obtain real-world statistics and create dynamic NFTs, a trend that is becoming increasingly popular as the NFT ecosystem expands.

The NBA uses Chainlink's oracles to power dynamic assets in The Association NFT series. Features include whether a player's team made it to the NBA Finals, the number of assists a player had in a game, and whether a player made a game-winning shot in the last 24 seconds of a game (Source: The Association NFT).
Some oracles are working to address MEV, described as one of Ethereum's biggest problems, the "invisible tax." API3 is an oracle focused on building decentralized APIs, using a system called "Oracle Extractable Value" designed to reduce MEV by sending extracted value back to dApps.

Oracles can also serve other important emerging areas of the crypto ecosystem. They can power prediction markets, allow Web3 users to move assets across cross-chain bridges, and help DAOs become trustless. oSnap, a UMA-driven solution developed using Snapshot and Safe, is an example of a new innovation that showcases the potential of oracles in the DAO space. While cross-chain bridges and DAOs are still in their early stages, they have already become important components of the Web3 ecosystem.

"If data exists on a decentralized blockchain, it should be verified in a decentralized manner."

But while DeFi is at the core of today's Web3, the true potential of oracles may be much greater. DeFi has already shown early signs of the promise that oracles provide, but in the coming decades, various data from the real world is likely to be moved on-chain.

This data could comprise online profiles of creators in Web3 social applications, weather events for insurance payouts, breaking reports for decentralized news services, or other application data that does not yet exist. Regardless of the form the data takes, if it exists on a decentralized blockchain, it should be verified in a decentralized manner.

How Oracles Make Trade-offs

The oracle problem is one of the biggest issues in crypto. So far, several projects with different solutions have emerged. However, they often make trade-offs, sacrificing core Web3 principles like decentralization.

Oracles are widely used to provide price information for tokens like BTC and ETH. Leading oracle solutions like Chainlink, Band Protocol, and Pyth primarily focus on price information. However, such price information is often limited in scope, with some covering only major on-chain assets. This means that certain areas of the ecosystem, such as niche emerging tokens or NFTs, are often overlooked.

Many oracles rely on nodes to submit data, which places trust in centralized parties. Cryptocurrency exchanges and market makers provide data for some oracles, meaning that oracles trust that the data they provide is accurate when it is on-chain. In extreme cases, nodes may provide inaccurate information for their own benefit.

Pyth relies on companies like Binance, Bitstamp, and CMS to publish data for its oracles (Source: Pyth Network).
Some of the most popular solutions aim to incentivize honest participation through staking mechanisms. For example, Chainlink rewards LINK stakers in its model called "explicit staking" for verifying data feeds. However, this model is susceptible to manipulation because it makes assumptions about the future income of honest participants (called "future fee opportunities"). Since a group of LINK stakers can profit more from validating inaccurate feeds than from their stake, this model poses manipulation risks for Chainlink. When this mechanism was unveiled in 2021, crypto researcher Eric Wall was one of its most outspoken critics.

UMA integrates a staking mechanism to encourage participation, but it differs from the mechanisms used by other oracles. $UMA stakers can earn rewards by staking their tokens and voting to protect the oracle. However, if they abstain or vote for an incorrect outcome in a dispute, their staked tokens will be redistributed. This mechanism is built on early proof-of-stake designs and game theory principles, making the data verification mechanism more robust.

While some oracles risk collusion among dishonest token holders, they may also manipulate their votes if the project team controls a significant portion of the token supply. In June 2022, Kleros faced manipulation allegations after a user was denied payment by the insurance protocol Unslashed Finance. Some claimed that Kleros team members used a large number of tokens to influence the vote; payment was denied.

The Fatal Flaw of DeFi

Oracles make DeFi work, but when they fail, they can cause problems for the entire ecosystem.

The killer app of DeFi is composability, but it can also be its fatal flaw. When one thing breaks, the problem can be widespread. If an oracle displays incorrect data, it can lead to a cascade of liquidations affecting many users.

During past periods of extreme volatility, oracles have struggled to maintain accurate price information. When the crypto market suffered extreme sell-offs on March 12, 2020, oracles displayed invalid price data, leading to widespread liquidations and bad debts for protocols like Maker. These events are referred to as Black Thursday. In recent years, some of DeFi's top protocols have begun using their own oracles to avoid reliance on a single solution, but they often have flaws. For example, Maker uses its own oracle to track collateral prices.

Oracle price feed attacks are one of the most common attacks in DeFi. A popular strategy is to take out a flash loan and use those funds to manipulate the asset prices in liquidity pools, then borrow more than the collateral deposited. Although DeFi protocols can mitigate such attacks by using multiple sources, they remain common.

Why Decentralization Matters

The current Web3 landscape highlights the importance of decentralized oracles. Since oracles provide the data that smart contracts read, we need to ensure that oracles work as intended while limiting trade-offs. DeFi has not collapsed in its early years, but it heavily relies on a few oracles.

"If the threats to Web3's oracles are significant today, they could be enormous in ten years."

In the current environment, a major oracle failure could lead to the collapse of DeFi. Today, the DeFi ecosystem is valued at around $50 billion, so the motivation for manipulation is high. However, the ecosystem still relies on solutions that may fail due to centralized setups.

If the threats to Web3's oracles are significant today, they could be enormous in ten years. If the space realizes its potential, DeFi will see significant growth once networks like Ethereum achieve scalability. As more data moves on-chain, oracles will become an important technology for verifying data owned by users in the network.

Given the important role oracles play in Web3, it is crucial that leading solutions are decentralized. If oracles are to serve as the truth machines for the next financial system, they also need to be very difficult to attack.

"Web3 oracles must be decentralized."

Both Bitcoin and Ethereum have costs of corruption. Ethereum's current market cap is around $184 billion, meaning that malicious actors would need over $92 billion worth of ETH to attack the network.

UMA also has costs of corruption; due to the economic guarantees of the protocol, bad actors will ultimately always spend more to attack the oracle than they might profit from it.

But few oracles can guarantee this. When the potential profits from manipulation may far exceed their stakes, it may encourage token holders to validate data through staking. In the worst-case scenario, oracles may use multi-signature wallets that only a few people can access.

The Elephant in the Room (Multi-signature)

DeFi and the broader Web3 space have rapidly evolved in recent years, but the multi-signature issue currently hinders its growth.

Many projects use multi-signature wallets to control their smart contracts, meaning they have a central point of failure. When a project is controlled by multi-signature, it is not always clear who is summoned as signers, why, whether they have good security hygiene, and whether they will act with honest intent. When security is a key feature of blockchains, multi-signature undermines security. We use networks like Bitcoin and Ethereum to secure value and hope to help this space grow. This means we need to ensure that security is always a top priority.

In a recent case highlighting the centralization risks of multi-signature wallets, the team behind Oasis Protocol ran a so-called "anti-exploitation" to recover $225 million from the Wormhole bridge hacker in its own multi-signature vulnerability. This move came after the High Court of England and Wales ordered Oasis to work with Jump Crypto to recover the funds. While it occurred after a malicious attack worth $325 million, the incident also focused on decentralization, blockchain immutability, and trusted neutrality. If Web3 users accept that multi-signature wallet controllers can seize funds based on court orders today, their own funds may be at risk if governments attempt to shut down protocols in the future. The U.S. Treasury controversially banned Tornado Cash in August 2022; some worry that, in the worst case, other popular protocols like Uniswap or Ethereum itself could be banned.

While most leading projects in cryptocurrency strive for decentralization, they sometimes rely on projects that use multi-signature wallets. Chainlink is the most widely used oracle solution in the field today, using a 4-of-9 multi-signature.

UMA advocates for the decentralized values of Web3. Without multi-signature control over contracts, any upgrades must be decided by UMA DAO voting. When UMA launches token staking in UMA 2.0 this month, it must be done in a trustless manner through governance.

oSnap is a UMA-based product designed to reduce Web3's reliance on multi-signatures. It enables DAOs to replace multi-signature with trustless governance, ushering in a new wave of Optimistic DAOs. If Web3 is to work, it needs decentralized governance and oracles.

The multi-signature issue in the oracle space raises two important questions for the Web3 community:

• If oracles trust a few individuals, are they decentralized enough to support decentralized networks?
• Should Web3 applications move away from multi-signature oracles or use multiple oracles to mitigate risk?

While some projects are taking action, such as diversifying their oracles to overcome the multi-signature issue, there is still a long way to go to achieve full decentralization in this space.

Price Feed Oracles and Optimistic Oracles

The core function of most oracles today is to provide price information. DeFi relies on accurate price information, so price feed oracles are at the heart of the crypto ecosystem. This setup is flawed because they often aggregate data from centralized sources and have limited scope.

UMA's optimistic oracle is a new approach to solving the oracle problem. In this design, game theory ensures honest coordination to find the true outcome, with trustlessness being key. The cost of disrupting the oracle exceeds the benefits, which is not the case for other solutions.

"Optimistic oracles are the right solution for establishing truth in the future of Web3."

Optimistic oracles also provide flexibility for price feed oracles: when Ethereum's Shanghai upgrade ships, you can use it to find out the price of ETH, regardless of whether it rained in New York City last night, or help a DAO adjust its collateral emissions.

While today's price feed oracles power DeFi, UMA believes that optimistic oracles are the right solution for establishing truth in the future of Web3. A few other projects, like Tellor and Reality, seem to agree, as they adopt similar approaches to UMA, using optimistic assertions to verify data. As more data moves on-chain, the benefits of optimistic oracles may become even more apparent.

Recent developments in zero-knowledge technology may also impact the future oracle space. Although zero-knowledge proofs have not yet truly disrupted Web3, emerging projects like Empiric Network (a ZK-based oracle on StarkNet's Layer 2) show early signs of how the field may evolve in the coming years.

What’s Next for Oracles in Web3?

UMA's ultimate goal is to support a vast ecosystem composed of trustless DeFi applications, DAOs, and other Web3 projects that value decentralization. Optimistic oracles have already proven their utility in powering applications like on-chain prediction markets and bridges, but the future opportunities are much greater.

Web3 may soon surpass niche markets like DeFi and NFTs, expanding into user-owned networks that protect valuable data for billions of users. With the emergence of smart contracts, this new internet could change our legal concepts as we know them. Data that exists on decentralized blockchains should be verified in a decentralized manner. This is why we believe that what we are building will be useful to the world.