In this article, I will attempt to discuss the current problems faced by the world of decentralized finance and how the Flare network can help solve them. I will also focus on explaining the basics of Oracle systems and discuss their weaknesses. Additionally, I will provide an overview of the functioning principles of the FTSO system in the Flare network.
Author: Andrzej Mackowiak
Ethereum was the first blockchain to introduce the concept of smart contracts. This was made possible by the creation of the Ethereum Virtual Machine (EVM), which is Turing complete. This means that the EVM mechanism is capable of executing any algorithm, regardless of its complexity.
EVM smart contracts enable the encoding of logic in a decentralized network, which ensures transparency and verifiability of applications. As an end user, you have to trust the smart contract code and the network protocol to perform the assigned task. This eliminates the need to rely on individuals or companies to keep their promises, as human factors are usually the biggest threat. However, it is important to remember that a smart contract is only as good as the programmer who wrote it.
Although smart contracts themselves were a significant step forward for cryptocurrencies, they wouldn’t be a complete solution without the ability to obtain data from the external world, known as an Oracle. The blockchain code remains on the blockchain and cannot interact with the external world. For those familiar with APIs, smart contracts alone CANNOT make API calls and, therefore, cannot retrieve data from sources other than the blockchain.
API (Application Programming Interface) is an interface for programming applications. It is a set of tools, protocols, and functions that enable communication between different applications or components of information systems.
API allows developers to access the functionality and data provided by other applications or services without needing to know the internal workings of those applications. This enables developers to leverage the features of other applications within their own applications.
In the context of blockchain, an Oracle refers to a special type of blockchain network node that serves to deliver information from external sources to smart contracts. The Oracle acts as an intermediary between the external world and the smart contract, providing information on which the contract can base its operations.
The type of information provided by an Oracle depends on the requirements and can include market data, financial data, or other external data that may impact the functioning of the smart contract. This enables smart contracts to respond to changes in the external world, increasing their flexibility and usefulness. Many companies utilize Oracle services in blockchain networks to provide cryptocurrency prices or other financial instrument data to their smart contracts.
Oracle is an integral part of decentralized finance.
Decentralized finance (DeFi) refers to the entire ecosystem of financial applications built on blockchain. It allows for conducting transactions without relying on banks or other financial institutions. All activities, including the signing of binding agreements (smart contracts), can be performed remotely using a smartphone. DeFi is an independent system separate from the traditional banking system, enabling users to interact and exchange value without intermediaries.
Oracle plays a crucial role in the DeFi sector, bridging the real world with the blockchain world. For DeFi applications to function and be valuable to people and organizations worldwide, they require real-world information such as price data. Currently, the market capitalization of the top 100 DeFi projects (value of tokens issued by them) exceeds $120 billion (as of March 2023).
The DeFi market still heavily relies on solutions that are not fully decentralized and do not provide 100% security. Solving this problem through Oracle is not easy, especially when building additional solutions on existing architecture. In such cases, we are unable to change the fundamental functioning principles.
As early as 2014, Vitalik Buterin noticed the challenge of providing market price information on the blockchain.
The biggest challenge for Oracle is to create economic incentives for data providers to ensure the prices they provide are precise and accurate while preventing the temptation to falsify the data. With billions of dollars flowing through the DeFi market, there is a risk of malicious actors taking advantage of the situation to harm the network. However, if Oracles are financially incentivized to continuously deliver precise and accurate data, they will continue their work without succumbing to fraudulent temptations, as it will not bring them financial benefits.
Commonly used and considered standard in DeFi, Oracle providers do not address the fundamental problem of lack of trust stemming from a centralized data delivery system.
In the recent past, we have witnessed numerous failures and attacks on DeFi, often caused by weak points in the system, such as Oracle. Ethereum, being the largest DeFi ecosystem, accounts for over 58% of the total liquidity in this market. The biggest attack on the DeFi market in 2022 was the Ronin bridge attack, resulting in losses of 173,600 ETH and $25.5 million in USDC, which was valued at over $625 million at the time. Similarly, in the case of the attack on the Compound protocol, which utilized exchange APIs, approximately $22 million was drained.
Flash loan attacks are often caused by the reliance of DeFi platforms on unstable price oracles. It is the role of oracles to maintain accurate price data for all cryptocurrencies available on the platform, which is not easy given the currently widely used standards. Secure but slow oracles are susceptible to arbitrage, while fast but unsafe oracles are prone to price manipulation. The latter often leads to flash loan attacks, which in 2021 extracted $364 million from DeFi platforms. In the case of the attack on Cream Finance, a series of flash loans exploiting a vulnerability in the way Cream calculated the “pricePerShare” variable for yUSD allowed the price of yUSD to be inflated to double its value, resulting in the sale of shares and an escape with $130 million, all in a single night. These two mentioned threats, inaccurate price oracles and poor-quality code, highlight the need for ensuring security. Decentralized price oracles can protect platforms from price manipulation by ensuring price accuracy. To ensure the security of smart contracts, code audits are conducted. However, code audits are not a guarantee of security. Nearly 30% of code attacks occurred on audited platforms, and even a staggering 73% of flash loan attacks. Therefore, DeFi protocols managing millions of users and billions of dollars must adopt a more comprehensive approach to platform security.
The exchange APIs themselves are not the source of the problem. However, the instability of the price data they provide can be problematic when large sums, worth millions or even billions of dollars, are at stake in secured positions or other derivative instruments. With the increasing adoption of tokenization, it becomes increasingly necessary to ensure a secure, accurate, decentralized, and trustless system for delivering prices from the real market. In the case of technology adoption by large financial institutions, the transfer of real-time price data to the blockchain will be a requirement for asset tokenization. A decentralized Oracle solution would be a perfect complement to decentralized finance.
Flare Network: FTSO Protocol
The Flare network proposes a decentralized price delivery solution on the blockchain. With key protocols like the State Connector and FTSO, it has the potential to achieve what Ethereum has not been able to do so far. These protocols are built into the underlying layer of the network, providing security and access to value. This value is built into the network layer, which means that anyone can interact with it (e.g., through Dapps) without special permissions. No one needs permission to access these protocols. Everyone can build on them, and that’s what will drive network effects in the future.
Flare Time Series Oracle (FTSO) protocol plays a crucial role in delivering data and rewards for the Flare network. It is referred to as the “heart” of the network by its creators.
Here’s how data delivery works on the Flare network. FTSO receives external data from Signal Providers, commonly known as Oracles in the blockchain world. Signal Providers exist off-chain, collecting data such as asset prices, and deliver them to FTSO on the Flare blockchain. FTSO verifies the accuracy of the data and then makes it available to network applications.
FTSO incentivizes honest participants through a rewards system. In Proof of Stake networks, network validators are required to deposit the native token as collateral. However, this solution is not scalable. As the value brought into the Proof of Stake network increases, more collateral is needed to secure the network. This hinders adoption and slows down the growth of the network’s value.
To illustrate this, let’s consider a stake worth $100 million. If we want to approve transactions worth $1 billion, the transaction value is ten times larger than the stake securing the network. Such a stake is not sufficient to secure the transaction value, which may tempt network participants to engage in dishonest behavior. These situations impede wider adoption of the DeFi market.
The Flare network takes a different approach, as the network’s security does not rely solely on the native token (FLR) as collateral. Consensus among network nodes is achieved through a Byzantine Fault Tolerant consensus mechanism, specifically the Avalanche consensus in a specially modified version called Snowman++. This is significant because this solution provides high security, fast transactions, and low fees, while the native token serves as an incentive for participants who use and develop the network. This approach allows Flare to be utilized by all of its holders for creating utility.
Flare Network: Signal Providers
Signal Providers are a crucial element of the Flare Network in terms of bringing real-world data onto the blockchain. They are off-chain systems that provide data to the Flare Time Series Oracle (FTSO) protocol. FTSO is responsible for making this data available to applications. Signal Providers play a vital role in the development of a decentralized network, as smart contracts alone cannot communicate with the off-chain world. Currently, Signal Providers on the Flare network are responsible for delivering reliable and accurate price data for supported tokens. In the future, they will also be responsible for providing data for any real-world asset that gets tokenized, as well as various types of data such as weather forecasts or football match results.
To incentivize Signal Providers to deliver accurate data, FTSO offers rewards in the form of Flare tokens (FLR) based on the quality of the provided data. Regular users can also receive rewards by delegating their votes to selected Signal Providers. Each Flare token (FLR) equals one vote that can be assigned to a chosen Signal Provider. Vote delegation is secure, as we never lose control over our FLR tokens, and votes can be withdrawn at any time without the risk of penalties.
Signal Providers deliver price data, such as the FLR/XRP price, to FTSO and are rewarded with FLR tokens based on the accuracy of their data. Accuracy is calculated by FTSO based on the weighted price of all signals for a specific asset within a defined time period. The price is weighted by the number of votes in each voting cycle, which occurs every 3 minutes.
This is a powerful mechanism that rewards signal providers for providing accurate data while enabling users who delegate their votes to signal providers to achieve risk-free profits. No FLR tokens can be lost if a vote does not make it into the median; the user simply does not receive a reward for that cycle.
How Flare Solves the Oracle Problem
One of the problems in the blockchain world that Flare Network addresses today is the issue of secure, reliable, and decentralized price delivery on the blockchain in a trustless manner. This is a very challenging problem to solve and has remained unresolved since the inception of the Ethereum network. It hinders the adoption of real-world applications and their widespread utilization. Until the emergence of the Flare network, we had not seen an Oracle system that was fully decentralized, trustless, and based on economic incentives, ensuring that data providers resist the temptation to manipulate data and are motivated to publish the most accurate information.
By incentivizing data providers to deliver the most accurate real-world data to the Flare network, it can be compared to rewarding miners for securing the Bitcoin network in Proof of Work consensus. Flare introduces a similar model but for delivering the most accurate price.
By engaging all users and token holders of the Flare network to delegate the value of their tokens to the most accurate price data providers and profit from it, Flare Network offers a solution that is entirely different from any other Oracle solution we have seen so far. All of this happens at the base layer of the blockchain, rather than a Layer 2 protocol with an additional token. The FLR token is the native token of the base layer network, generating profits, granting governance rights, and serving as collateral (f-assets).
By deriving financial benefits from delegating their votes to the most accurate data providers, users also have the ability to change and withdraw their votes. This solution operates like a liquid democracy, rewarding the best and most honest price providers. Over 100 independent entities currently vote on the price of each asset. All of this makes the solution highly accurate and decentralized. This is made possible by embedding the necessary protocols into the base layer of the blockchain and utilizing the native token for incentives. Trying to build something similar at a higher layer (Layer 2) of the Ethereum network would face limitations in the form of higher gas fees, making it completely unfeasible.
Through the two protocols integrated into the base layer (FTSO and State Connector), Flare Network addresses the Oracle problem in two categories: probabilistic and deterministic data.
Probabilistic data refers to data that is uncertain or has a degree of randomness associated with it. This means that the data cannot be predicted with complete accuracy but rather with a certain degree of probability. Examples of probabilistic data include weather forecasts, stock market predictions, and medical diagnoses based on symptoms.
Deterministic data refers to data that is certain and predictable. This means that the data can be precisely predicted and calculated without any degree of randomness. Examples of deterministic data include mathematical equations, physical laws, and computer algorithms.
In summary, probabilistic data is uncertain and has a degree of randomness, while deterministic data is certain and predictable. When we ask a binary question of yes or no or one or zero, deterministic data allows for a precise answer.
Flare Network’s unique and revolutionary approach to Oracle technology represents a significant advancement in the DeFi space. By providing a more secure, reliable, and efficient platform for executing smart contracts and processing data, Flare Network has the potential to significantly improve user experiences and increase adoption rates of DeFi applications.
Through its innovative utilization of the Federated Byzantine Agreement (FBA) consensus mechanism and the incorporation of trusted validators from multiple blockchain networks, Flare Network has the potential to be a game-changer in the world of DeFi. Its ability to enable interoperability and transactions between different blockchain networks through the use of its native token can enhance the adoption and integration of DeFi in various blockchain ecosystems.
Despite its well-thought-out network architecture, Flare Network still faces challenges in terms of broader adoption. One of these challenges is educating developers about the new paradigm now available on Flare and how they can leverage it to their advantage. Developers need to change their mindset from building products solely on one chain to building a much better product that can operate on multiple chains simultaneously. Most developers are effectively “locked in” to the existing model or are unaware of the possibilities offered by Flare.
As the DeFi market continues to evolve and mature, Flare Network’s approach to Oracle technology may serve as a model for other blockchain projects to follow. By addressing the limitations and inefficiencies of current DeFi Oracle systems, Flare Network is helping to build a more robust and resilient decentralized financial infrastructure that can meet the needs of users and developers.
I highly encourage you to explore the linked resources, which are largely the source materials for the above article.
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