Is Flare Network a solution for Oracle problem?
For readers who come across this article for the first time or are not familiar with the basics of how the Flare network operates, I recommend reading my previous article on this topic, the link to which can be found here:
It is worth noting, however, that although FLR tokens have only been available on the market for three months, the canary network has been operating for almost a year and a half, and the Flare Network project has been functioning and developing since 2017.
In this article, I will try to discuss the current problems that the world of decentralized finance is facing and how the Flare network can help solve them. I will also focus on explaining the basics of how Oracle systems work and discuss their weaknesses. I will also explain the principles of how the FTSO system operates in the Flare network.
Oracle
Ethereum was the first blockchain to introduce the concept of smart contracts. This was made possible by creating the Ethereum Virtual Machine (EVM), which is Turing complete. This means that the EVM mechanism is able to run any algorithm, regardless of its complexity.
EVM smart contracts allow for coding logic in a decentralized network, which in turn provides transparency and verifiability of applications. As an end user, you have to trust the smart contract code and network protocol to perform the task entrusted to them. This means that you don't have to rely on people or companies to keep their word, as human error is usually the biggest threat. However, it's worth remembering that a smart contract is only as good as the programmer who wrote it.
Although smart contracts were a huge step forward for cryptocurrencies, they wouldn't be a complete solution if it weren't for the ability to obtain data from the outside world, known as an Oracle. Blockchain code remains on the blockchain and cannot communicate with the outside world. For people who know what an API is, smart contracts alone CANNOT make API calls and therefore cannot retrieve data from sources other than the blockchain.
API (Application Programming Interface) is an application programming interface. It is a set of tools, protocols, and functions that enable communication between different applications or components of information systems.
API, or application programming interface, allows programmers to access the functionality and data provided by other applications or services without needing to know the details of their internal workings. This enables programmers to use other applications' functions within their own application.
In the context of blockchain, an Oracle refers to a special type of blockchain network node that is used to provide 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 operation.
The type of information provided by the Oracle depends on the needs and can be information about the state of the market, financial data, or other external data that may affect the operation of the smart contract. This allows smart contracts to respond to changes in the external world, increasing their flexibility and usefulness. Many companies use Oracle services on the blockchain network to provide information on cryptocurrency or other financial instrument prices to their smart contracts.
Oracle - an integral part of decentralized finance.
The term decentralized finance (DeFi) refers to the entire ecosystem of financial applications based on blockchain technology. It enables transactions to be carried out without the need for banks or other financial institutions. All actions, including the signing of a binding contract (smart contract), can be performed remotely using a smartphone. DeFi is an independent system of finance that allows users to interact and exchange without intermediaries, regardless of the existing banking system.
Oracle plays a crucial role in the DeFi sector, connecting the real world with the blockchain world. To make DeFi applications work and be valuable to people and organizations around the world, they need information from the real world, such as price data. Currently, the market capitalization of the top 100 DeFi projects (the value of tokens issued by them) is over $120 billion (as of March 2023).
The DeFi market still largely relies on solutions that are not fully decentralized and do not provide 100% security. Solving this problem by Oracle is not easy, especially when building new solutions on an existing architecture. In this case, we cannot change the fundamentals of their functioning.
As early as 2014, Vitalik Buterin noticed the problem of providing market price information on the blockchain.
The biggest challenge for Oracle is to create an economic incentive for data providers to ensure that the prices they provide are precise and accurate, while preventing the temptation to falsify that data. When billions of dollars flow through the DeFi market, there is a risk of so-called "bad actors" who will take advantage of the situation to harm the network. However, if Oracle are financially incentivized to continuously provide precise and accurate data, they will continue their work without succumbing to the temptation to cheat, as it will not bring them financial benefits.
Commonly used and considered a standard in DeFi, Oracle providers do not solve the fundamental problem of lack of trust resulting from a centralized data delivery system.
In the recent past, we have had many failures and attacks on DeFi, most often caused by weak points in the system, such as Oracle. Ethereum, 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 attack on the Ronin bridge, which caused losses of 173,600 ETH and $25.5 million in USDC, which was then worth over $625 million. In the case of the attack on the Compound protocol, which used exchange APIs, approximately $22 million was drained.
Flash loan attacks are often caused by DeFi platforms' reliance on unstable price oracles. Oracles are responsible for maintaining accurate price data for all cryptocurrencies available on the platform, which is not easy given the currently widely used standards. Safe but slow oracles are vulnerable to arbitrage, while fast but risky oracles are exposed 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 the Cream Finance platform, a series of flash loans exploiting a vulnerability in the way Cream calculated the "pricePerShare" of yUSD allowed the price of yUSD to be inflated to twice its value, allowing for the sale of shares and an escape with $130 million overnight. The aforementioned threats, inaccurate price oracles and poor quality code, highlight the need for security. To ensure price accuracy, decentralized price oracles can protect platforms from price manipulation attacks. 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 a staggering 73% of flash loan attacks. Therefore, DeFi protocols managing millions of users and billions of dollars must adopt a more sophisticated approach to platform security.
An exchange APIs themselves are not the source of the problem. However, the instability of the price data they provide can be problematic when large amounts, worth millions or even billions of dollars, are at stake in secured positions or other derivative instruments. With the growing adoption of tokenization, it is becoming increasingly necessary to provide a secure, accurate, decentralized, and trustless system for delivering prices from the real market. In the case of technology adoption by large financial institutions, transferring current 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. Thanks to the key protocols, State Connector and FTSO, it has a chance to achieve what Ethereum has not been able to do so far. These protocols are built into the network's base layer, which ensures their security and access to value. This value is embedded in 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. Anyone can build on them, and that is what drives network effects in the future.
The Flare Time Series Oracle (FTSO) protocol plays a crucial role in providing data and rewards for the Flare network. It is referred to by the creators as the beating heart of the network.
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 outside of the blockchain, collect data such as asset prices, and deliver them to FTSO on the Flare blockchain. FTSO verifies that the data is accurate and then makes it available to network applications.
The first type of data that Flare Time Series Oracle (FTSO) accepts from signal providers is price data for supported cryptocurrencies expressed in US dollars. This allows the first wave of web applications to use these channels.
FTSO encourages honest users to participate through a reward system. In the case of Proof of Stake networks, the units securing the network (validators) must deposit the network's native token as collateral. This solution is not scalable. The more value the Proof of Stake network brings, the more collateral is needed to secure the network. This blocks adoption and slows down the growth of this value.
This can be illustrated as follows: with a stake worth $100 million, we want to approve transactions worth $1 billion, which means the transaction is 10 times larger than the stake securing the network. Such a stake is not sufficient to secure the transaction value, which may encourage network participants to engage in dishonest behavior. These situations are a barrier to wider adoption of the DeFi market.
In the Flare Network, the approach is different because the network's security does not rely on the Flare (FLR) native token that secures the network. Node agreement is achieved using Byzantine Fault Tolerant consensus, specifically Avalanche consensus in a specially modified version of Snowman++. This is important because this solution provides the network with high security, fast transactions, and low fees, while the native token serves as an incentive for participants who use and develop the network. Thanks to this solution, Flare can be used to create utility by all its holders.
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Flare Network: Signal Providers
Signal Providers are an important part of the Flare Network system when it comes to bringing real-world data onto the blockchain. These are off-chain systems that provide data to the Flare Time Series Oracle (FTSO) protocol, which is responsible for making that data available to applications. Signal Providers play a crucial role in developing a decentralized network because smart contracts themselves cannot communicate with the off-chain world. Currently, on the Flare network, the role of Signal Providers is to provide reliable and accurate price data for tokens supported on the network. In the future, however, Signal Providers will be responsible for providing data for any asset from the real-world market that is tokenized, as well as for various types of data such as weather forecasts or football match results.
To incentivize Signal Providers to provide accurate data, FTSO offers rewards in the form of Flare tokens (FLR), depending on the quality of the data provided. Ordinary users can also receive rewards by delegating their votes to Signal Providers of their choice. Each Flare token (FLR) equals one vote, which can be assigned to a chosen Signal Provider. Delegating votes is secure because we never lose control of our FLR tokens, and votes can be withdrawn at any time without the risk of penalty.
Signal Providers provide 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 given asset in a specific time period. The price is weighted by the number of votes in each voting cycle. Voting cycles take place every 3 minutes.
This is a powerful mechanism that rewards signal providers for providing accurate data, while also allowing users who delegate their votes to signal providers to profit without risk. Users cannot lose any FLR tokens if their vote does not make it to the median; they simply do not receive a reward for that cycle.
FTSO workflow
How Flare solves the Oracle problem
One of the problems in the blockchain world that Flare Network is already solving today is the issue of secure, reliable, and decentralized price delivery to the blockchain without requiring trust in a third party. This is a very difficult problem to solve that has not been fixed since the creation of the Ethereum network, and it hinders the adoption of real-world applications and their widespread use. Until the emergence of the Flare Network, we did not see an Oracle system that was fully decentralized, trustless, and based on economic incentives, so that data providers would not be tempted to manipulate data and would be motivated to publish the most up-to-date information.
Thanks to this, data providers on the Flare network are motivated to provide the most accurate real-world data on the blockchain. This can be compared to rewarding miners for securing the Bitcoin network through Proof of Work consensus. Flare introduces a similar model, but in order to provide the most accurate price data.
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 derive financial benefits from it, Flare Network offers a solution that is completely different from any other Oracle solution we have seen so far. All of this happens at the first layer of the blockchain, not at the Layer 2 protocol with an additional token. The FLR token is the native token of the first-layer network, which generates profits, grants governance rights, and can be used as collateral (f-assets).
By deriving financial benefits from delegating their votes to the signal provider who provides the most accurate data, users also have the ability to change and withdraw their vote. This solution functions like a liquid democracy, rewarding the best and most honest price providers. More than 100 independent entities currently vote on the price of each asset. All of this makes this solution extremely accurate and decentralized. This is made possible by embedding the necessary protocols in the first layer of the blockchain and using the native token for incentives. Attempting to build something similar at the higher layer (Layer 2) of the Ethereum network would face limitations in the form of higher gas fees, which would make it completely unprofitable.
Thanks to the two protocols embedded in the first layer (FTSO and State Connector), the Flare network solves 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 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 data can be accurately 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 such as yes or no or one or zero, deterministic data allows for a precise answer.
Conclusion
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 innovative use of the Federated Byzantine Agreement (FBA) consensus mechanism and the incorporation of trusted validators from multiple blockchain networks, Flare Network has the potential to become a "game changer" in the world of DeFi. Its ability to enable interoperability and transactions between different blockchain networks using its native token could increase adoption and integration of DeFi in various blockchain ecosystems.
Despite a carefully designed network architecture, Flare Network faces some challenges related to broader adoption. One of the challenges is educating developers about the new paradigm that is now available on Flare and how they can benefit from it. Developers need to change their ways of thinking to no longer think about the need to build products only on one chain, but to build a much better product that can work on multiple chains at the same time. Most developers are essentially "prisoners" of the existing model or are unaware of the opportunities that Flare offers.
As the DeFi market continues to grow 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 sincerely encourage you to review the linked materials, which are largely the source materials for the above article.
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